Equity method investments and joint ventures (issued

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Equity method investments and joint venturesNovember 2020

About the Equity method investments and joint ventures guide

PwC is pleased to offer the first edition of our Equity method investments and joint ventures guide.

This guide discusses the identification of investments that are subject to the equity method of

accounting guidance, and the initial and subsequent accounting for those investments. It also includes

discussion of the accounting upon formation of a joint venture.

This guide summarizes the applicable accounting literature, including relevant references to and

excerpts from the FASB’s Accounting Standards Codification (the Codification). It also provides our

insights and perspectives, interpretative and application guidance, illustrative examples, and

discussion on emerging practice issues.

This guide should be used in combination with a thorough analysis of the relevant facts and

circumstances, review of the authoritative accounting literature, and appropriate professional and

technical advice.

References to US GAAP

Definitions, full paragraphs, and excerpts from the FASB’s Accounting Standards Codification are

clearly labelled. In some instances, guidance was cited with minor editorial modification to flow in the

context of the PwC Guide. The remaining text is PwC’s original content.

References to other PwC guidance

This guide provides general and specific references to chapters in other PwC guides to assist users in

finding other relevant information. References to other guides are indicated by the applicable guide

abbreviation followed by the specific section number. The other PwC guides referred to in this guide,

including their abbreviations, are:

□ Business combinations and noncontrolling interests (BCG)

□ Consolidation (CG)

□ Derivatives and hedging (DH)

□ Fair value measurements, global edition (FV)

□ Financial statement presentation (FSP)

□ Financing transactions (FG)

□ Foreign currency (FX)

□ Income taxes (TX)

□ Loans and investments (LI)

□ Property, plant, equipment and other assets (PPE)

□ Stock-based compensation (SC)

About this guide

Copyrights

This publication has been prepared for general informational purposes, and does not constitute

professional advice on facts and circumstances specific to any person or entity. You should not act

upon the information contained in this publication without obtaining specific professional advice. No

representation or warranty (express or implied) is given as to the accuracy or completeness of the

information contained in this publication. The information contained in this publication was not

intended or written to be used, and cannot be used, for purposes of avoiding penalties or sanctions

imposed by any government or other regulatory body. PricewaterhouseCoopers LLP, its members,

employees, and agents shall not be responsible for any loss sustained by any person or entity that

relies on the information contained in this publication. Certain aspects of this publication may be

superseded as new guidance or interpretations emerge. Financial statement preparers and other users

of this publication are therefore cautioned to stay abreast of and carefully evaluate subsequent

authoritative and interpretative guidance.

The FASB Accounting Standards Codification® material is copyrighted by the Financial Accounting

Foundation, 401 Merritt 7, Norwalk, CT 06856, and is reproduced with permission.

Chapter 1: Scope

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1.1 Overview of equity method investments

Equity investments represent an ownership interest (for example, common, preferred, or other capital

stock) in an entity, and may be made in a variety of legal entities, such as corporations, limited liability

partnerships, or limited liability corporations.

The accounting for an equity investment depends on the degree to which the investor can influence the

investee. An investor that directly or indirectly holds a controlling financial interest in another entity is

required to consolidate that entity pursuant to either the variable interest entity (VIE) or voting

interest entity consolidation model, as prescribed by ASC 810, Consolidation. This determination may

require extensive analysis depending on the terms and nature of the investment. See CG 2 and CG 3

for further information regarding the application of the VIE and VOE consolidation models,

respectively.

Once an investor has determined that it does not have a controlling financial interest, it should

determine if the equity method of accounting applies, as prescribed by ASC 323, Investments – Equity

Method and Joint Ventures. The equity method is used to account for investments in common stock or

other eligible investments by recognizing the investor’s share of the economic resources underlying

those investments. Investments within the scope of the equity method include investments in either

common stock and/or in-substance common stock of corporate entities, as well as investments in

entities such as partnerships, unincorporated joint ventures, and limited liability companies. The

equity method is applied if these investments provide the investor with the ability to exercise

significant influence over the investee. See EM 1.2 and EM 1.3 for further discussion of these

investments and EM 2 for further discussion of the concept of significant influence.

There are certain exclusions to applying the equity method of accounting, such as when an investor

has elected to measure an investment at fair value or is applying the proportionate consolidation

method allowed in limited circumstances in certain industries. See EM 1.4 for further information

regarding these exclusions.

An investment that, individually or in combination with other financial and nonfinancial interests,

does not provide the investor with the ability to exercise significant influence should be accounted for

under other accounting guidance (e.g., ASC 320, Investments – Debt Securities or ASC 321,

Investments – Equity Securities).

1.1.1 Framework to determine if the equity method applies

The following framework illustrates the accounting for equity investments and should be read in

conjunction with the referenced sections.

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Figure EM 1-1 Framework to determine those investments that should be accounted for under the equity method of

accounting

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1.2 Investments in common stock

Common stock is subordinate to all other equity of the issuer and is often referred to as residual

equity. A share of common stock usually provides its holder with voting rights, which enables it to

influence the operating and financial policies of an investee. Common stock represents the residual

value of an entity after all senior interests (e.g., liabilities, senior classes of equity) have been

accounted for.

1.2.1 In-substance common stock investments

An investor may hold stock or other instruments that have risk and reward characteristics that are

substantially similar to common stock. These instruments are commonly referred to as in-substance

common stock investments.

To determine whether an investment is “substantially similar” to common stock, an investor should

consider the following characteristics outlined in ASC 323-10-15-13:

□ Subordination (see EM 1.2.1.1)

□ Risks and rewards of ownership (see EM 1.2.1.2)

□ Obligation to transfer value (see EM 1.2.1.3)

If any of these characteristics of the investment are not substantially similar to common stock, the

investment is not in-substance common stock and would not be within the scope of ASC 323. In that

case, the investor should not apply the equity method of accounting, even if the investor has significant

influence.

If an investor cannot make a determination based on a qualitative assessment of these characteristics,

the investor should perform a quantitative assessment by analyzing whether the future changes in the

fair value of the investment are expected to vary directly with the changes in the fair value of the

investee’s common stock. If not, the investment is not considered in-substance common stock.

Paragraph 5 of EITF 02-14 noted that investments in other non-corporate entities, such as

partnerships or limited liability companies, are not subject to the in-substance common stock

guidance. While not included in the FASB codification, we believe this guidance should still be

followed when determining scope. Therefore, these investments should be accounted for under ASC

323-30-15-2. See EM 1.3 for further information.

1.2.1.1 Subordination criterion — in-substance common stock

An investment without a stated liquidation preference, or with a nonsubstantive liquidation

preference, over the investee’s common stock, may be substantially similar to common stock and

further analysis of the other criteria will be needed. In contrast, an investment with a substantive

liquidation preference over common stock is not substantially similar to that entity’s common stock.

An investor should consider the following when assessing if a stated liquidation preference is

substantive:

□ The liquidation preference may be substantive if it is significant in relation to the purchase price of

the investment.

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□ A liquidation preference in an investment is more likely to be substantive when the fair value of

subordinated equity (i.e., the investee’s common stock) is significant. Conversely, if there is little

or no fair value associated with the investee’s common stock, the investment would participate in

substantially all of the investee’s losses in the event of liquidation, and the liquidation preference

would not be considered substantive.

Example EM 1-1, Example EM 1-2, and Example EM 1-3 illustrate the evaluation of whether an

investment has substantially similar subordination as common stock.

EXAMPLE EM 1-1

Investee’s common stock has little fair value

On January 1, 20X0, Investor purchased 200,000 shares of preferred stock of Investee in exchange for

$20,000,000 ($100 par value, liquidation preference of $100 per share). On January 1, 20X0, the fair

value of Investee’s outstanding common stock was $300,000.

Investor has the ability to exercise significant influence over Investee’s operating and financial policies

through its investment in Investee.

Are the subordination characteristics of Investor’s investment in the preferred stock of Investee

substantially similar to the subordination characteristics of Investee’s common stock?

Analysis

The liquidation preference stated in the preferred stock of Investee is equal to the purchase price (and

fair value) of the preferred stock on the date of purchase. Therefore, the stated liquidation preference

is significant in relation to the purchase price of the investment. However, the fair value of Investee’s

common stock ($300,000), compared to the fair value of Investee’s preferred stock ($20,000,000),

indicates that Investee’s common stock has little fair value compared to the investment.

In the event of liquidation, Investor’s investment, while preferred stock, would likely participate in

substantially all of Investee’s losses. As a result, it’s likely that the liquidation preference in its

investment in the preferred stock of Investee is not substantive and that the subordination

characteristic of its investment in the preferred stock of Investee are substantially similar to that of the

Investee’s common stock.

Investor should also evaluate the risks and rewards of ownership (see EM 1.2.1.2) and obligation to

transfer value (see EM 1.2.1.3) to determine whether its investment in the preferred stock of Investee

is in-substance common stock.

EXAMPLE EM 1-2

Liquidation preference is insignificant in relation to the purchase price of the investment



value of Investee’s outstanding common stock was $100,000,000.



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Analysis

The liquidation preference stated in the preferred stock of Investee is equal to 1% ($1 per share divided

by $100 per share) of the purchase price (and fair value) of the preferred stock on the date of purchase.

The fair value of Investee’s common stock ($100,000,000), as compared to the fair value of Investee’s

preferred stock ($20,000,000), indicates that Investee has significant value associated with its

common stock from a fair value perspective.

Given that the liquidation preference is only 1% of the purchase price, Investor is likely to conclude

that the liquidation preference of its investment is not substantive and that the subordination

characteristic is substantially similar to the subordination characteristics of Investee’s common stock.

Investor should also evaluate the risks and rewards of ownership (see EM 1.2.1.2) and obligation to

transfer value (see EM 1.2.1.3) criteria in its determination of whether its investment in the preferred

stock of Investee is in-substance common stock.

EXAMPLE EM 1-3

Subordination is not substantially similar to common stock



value of Investee’s outstanding common stock was $100,000,000.





Analysis

The liquidation preference stated in the preferred stock of Investee is equal to the purchase price (and

fair value) of the preferred stock on the date of purchase and, consequently, the stated liquidation

preference is significant in relation to the purchase price of the investment. Further, the fair value of

Investee’s common stock ($100,000,000), as compared to the fair value of Investee’s preferred stock

($20,000,000), indicates that the Investee common stock has significant fair value.

Therefore, in the event of liquidation, Investor’s investment in the preferred stock of Investee would

likely be protected through the existence of Investee’s common stock, which would most likely absorb

a substantial portion of the losses of Investee. As a result, Investor might conclude that the liquidation

preference in its investment in the preferred stock of Investee is substantive and that the

subordination characteristics of its investment in the preferred stock of Investee are not substantially

similar to the subordination characteristics of Investee’s common stock. If so, the preferred stock

would not be considered in-substance common stock.

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Investor would not be required to evaluate the risks and rewards of ownership and obligation to

transfer value criteria once the subordination criterion is not met.

1.2.1.2 Risks and rewards of ownership — in-substance common stock

An investment is not substantially similar to common stock if it is not expected to participate in the

earnings (and losses) and capital appreciation (and depreciation) in a manner that is substantially

similar to common stock.

For example, if an investee pays dividends on common stock and the investment participates in a

substantially similar manner, it indicates that the investment is substantially similar to common stock.

Investors should consider whether the investee is expected to pay dividends when determining if

participation in dividends is relevant to assessing risks and rewards of ownership.

The ability to convert an investment into that investee’s common stock without any significant

restrictions or contingencies may indicate that the investor may participate in capital appreciation of

the investee in a manner that is substantially similar to common stock. In making a determination, an

investor would also consider the risks inherent in the investment.

Example EM 1-4 and Example EM 1-5 illustrate the evaluation of whether an investment is expected to

participate in the risks and rewards of ownership of common stock.

EXAMPLE EM 1-4

Investment expected to participate in risks and rewards of ownership

On January 1, 20X0, Investor purchased a warrant for $1,000,000. The warrant enables Investor to

acquire 50,000 shares of Investee’s common stock at an exercise price of $1.50 per share (total

exercise price of $75,000). The warrant is exercisable at any time on or before December 31, 20X0.

There are no significant restrictions or contingencies associated with Investor’s ability to exercise the

warrant. The warrant does not participate in dividends paid to the common shareholders of Investee.

However, Investor does not expect Investee to pay dividends to its common shareholders during the

exercise period (January 1, 20X0 – December 31, 20X0). On January 1, 20X0, the fair value of

Investee’s common stock is approximately $21.00.



Is Investor’s investment expected to participate in Investee’s earnings (and losses) and capital

appreciation (and depreciation) in a manner that is substantially similar to Investee’s common stock?

Analysis

Investor can exercise the warrant and convert its investment to common stock at any time during the

exercise period, without any significant restrictions or contingencies; therefore, Investor’s investment

enables it to participate equally with the common shareholders in increases in Investee’s fair value.

Investor also does not expect Investee to pay dividends to its common shareholders during the

exercise period; therefore, dividends that could become payable to common shareholders are not

expected to result in a difference in the earnings and losses available to the (a) Investor’s investment

(warrant) and (b) Investee’s common shares.

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Investors have alternatives in making this assessment. In this case, the current fair value of Investee’s

common stock ($21.00) is substantially similar to the current fair value of a warrant to purchase one

share of common stock ($20.00, or $1,000,000/50,000). Therefore, the warrant’s expected

participation in Investee’s capital appreciation and depreciation is substantially similar to the common

shareholders’ participation.

As a result, Investor is likely to conclude that, before exercise, the warrant is expected to have risks

and rewards of ownership substantially similar to common stock, i.e., the warrant participates in

Investee’s earnings (and losses) and capital appreciation (and depreciation) in a manner that is

substantially similar to common stock.

Investor should also evaluate the subordination (see EM 1.2.1.1) and obligation to transfer value (see

EM 1.2.1.3) criteria in its determination of whether its warrant is in-substance common stock.

EXAMPLE EM 1-5

Investment not expected to participate in risks and rewards of ownership

On January 1, 20X0, Investor purchased a warrant for $150,000. The warrant enables Investor to

acquire 50,000 shares of Investee’s common stock at an exercise price of $19.00 per share (total

exercise price of $950,000). The warrant is exercisable at any time on or before December 31, 20X0.

There are no significant restrictions or contingencies associated with Investor’s ability to exercise the

warrant. The warrant does not participate in dividends paid to the common shareholders of Investee.

However, Investor does not expect Investee to pay dividends to its common shareholders during the

exercise period (January 1, 20X0 – December 31, 20X0). On January 1, 20X0, the fair value of

Investee’s common stock is $21.00.



Is Investor’s investment expected to participate in Investee’s earnings (and losses) and capital

appreciation (and depreciation) in a manner that is substantially similar to Investee’s common stock?

Analysis

Investor can exercise the warrant and convert its investment to common stock at any time during the

exercise period, without any significant restrictions or contingencies; therefore, Investor’s investment

enables it to participate equally with the common shareholders in increases in Investee’s fair value.

Investor also does not expect Investee to pay dividends to its common shareholders during the

exercise period; therefore, dividends that could become payable to common shareholders are not

expected to result in a difference in the earnings (and losses) available to the (a) Investor’s investment

(warrant) and (b) Investee’s common shares.

The current fair value of Investee’s common stock ($21.00) is substantially different from the current

fair value of a warrant (for this scenario, assume intrinsic value equals fair value) to purchase one

share of common stock ($3.00, or $150,000/50,000). Therefore, the warrant’s expected participation

in Investee’s capital depreciation is substantially different from the common shareholders’

participation. Specifically, Investor’s investment in the warrant has substantially less at risk in the

event of capital depreciation than Investee’s common shares.

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As a result, Investor is likely to conclude that, before exercise, the warrant is not expected to

participate in Investee’s earnings (and losses) and capital appreciation (and depreciation) in a manner

that is substantially similar to common stock. Therefore, the warrant is not in-substance common

stock.

Investor would not be required to evaluate the subordination and obligation to transfer value criteria

once the risks and rewards of ownership criterion is not met.

1.2.1.3 Obligation to transfer value – in-substance common stock

An investment is not substantially similar to common stock if the investee is expected to transfer

substantive value to the investor that is not also available to common shareholders. An example of this

may be an investment that includes a fixed price mandatory redemption provision or a non-fair value

put option that is not available to common shareholders.

An investor should evaluate whether provisions to transfer value are substantive obligations. For

example, preferred stock with a mandatory redemption in 100 years is not considered a substantive

obligation to transfer value through the redemption feature, given the extreme long-dated nature of

the specified future date. Alternatively, if an investee does not have the ability to pay the related

redemption price that the investor is or would be entitled to at the time of investment, the redemption

provision would also not be considered a substantive obligation to transfer value.

Example EM 1-6 and Example EM 1-7 illustrate the assessment if an Investee is obligated to transfer

substantive value.

EXAMPLE EM 1-6

Investee not obligated to transfer substantive value

On January 1, 20X0, Investor purchased 1,000,000 shares of redeemable convertible preferred stock

in Investee for $5,000,000. At the date of the investment, 100% of Investee’s common stock was

valued at $400,000. The preferred shares can be converted into common shares on a one-for-one

basis, or redeemed for $5,000,000. The common shareholders of Investee do not have a redemption

feature.



Does the redemption feature obligate Investee to transfer substantive value to Investor that is not also

available to common shareholders?

Analysis

The $5,000,000 redemption feature is substantive as compared to the fair value of the investment

($5,000,000) on the investment date. However, given that the fair value of the Investee’s common

stock was $400,000, Investor is likely to conclude that Investee would not have the ability to pay the

redemption amount if exercised. If Investee’s operating results deteriorated, the common shareholders

would not be able to absorb significant losses and it would be unlikely that Investee would have the

ability to redeem Investor’s preferred stock at the $5,000,000 redemption amount. Therefore,

Investor’s redemption feature is not considered substantive as Investee is not expected to transfer

substantive value to the Investor.

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Investor should also evaluate the subordination (see EM 1.2.1.1) and risks and rewards of ownership

(see EM 1.2.1.2) criteria in its determination of whether its investment is in-substance common stock.

EXAMPLE EM 1-7

Investee obligated to transfer substantive value

On January 1, 20X0, Investor purchased 1,000,000 shares of redeemable convertible preferred stock

in Investee for $5,000,000. At the date of the investment, 100% of Investee’s common stock was

valued at $10,000,000. The preferred shares can be converted into common shares on a one-for-one

basis, or redeemed for $5,000,000. The common shareholders of Investee do not have a redemption

feature.



Does the redemption feature obligate Investee to transfer substantive value to Investor that is not also

available to common shareholders?

Analysis

The redemption feature is substantive. The fair value of Investee’s common stock was $10,000,000

and Investor concluded when it made the investment that Investee had the ability to pay the

redemption amount if exercised. Therefore, Investor’s investment in the redeemable convertible

preferred stock obligates Investee to transfer substantive value to Investor that is not available to

Investee’s common shareholders. As such, the redeemable convertible preferred stock is not in-

substance common stock.

Investor would not be required to evaluate the subordination and risk and rewards of ownership

criteria once the obligation to transfer value criterion was not met.

1.2.1.4 Initial determination and reconsideration events

Investors should determine whether an investment is substantially similar to common stock based on

information that exists on the date the investor determines that it has the ability to exercise significant

influence. This date may be subsequent to the date that the investment was originally acquired. For

example, subsequent to an initial investment, an investor may obtain representation on the board of

directors that gives it the ability to exercise significant influence over the investee’s operating and

financial policies. At this point, the investor would perform the initial assessment as to whether its

investment is considered in-substance common stock.

As noted in ASC 323-10-15-16, an investor should reconsider its initial determination if any of the

following occur:

□ The contractual terms of the investment are amended, resulting in a change in one or all of the

characteristics described in EM 1.2.1. For example, a change in the form of the investment, such as

an exchange of preferred stock for another series of stock, is generally considered a

reconsideration event. An expected change provided for in the original terms of the contractual

agreement would generally not be considered a reconsideration event.

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□ There is a significant change in the investee’s capital structure, including the investee’s receipt of

additional subordinated financing. For example, an increase in both the number of shares and

value of outstanding common stock could affect whether the subordination characteristics of an

investment are substantially different from that of common stock.

□ The investor obtains an additional interest in the investment. When reconsidering the

characteristics of the investment, an investor should consider its cumulative position in the

investment (including both new and existing interests) and the facts and circumstances that

existed at the time the additional interest was acquired.

The determination of whether an investment is similar to common stock should not be reconsidered solely due to losses of the investee, even if those losses change the investee’s capital structure. Rather, an investor should only reconsider whether its investment is substantially similar to common stock when one of the identified reconsideration events or conditions occurs.

1.2.1.5 Put or call option representing in-substance common stock

An investor may obtain an instrument, such as a put or call option, that provides it with the right to purchase or sell the voting common stock of an investee at a future point in time. The investor must determine whether these instruments represent in-substance common stock. In performing this evaluation, an investor should first determine whether the instrument is a freestanding instrument or an embedded feature within a host agreement that might require bifurcation and separate accounting.

If the instrument is freestanding, the investor should determine whether it should be accounted for pursuant to ASC 815, Derivatives and Hedging. If the instrument is an embedded feature within a host agreement, the investor should evaluate whether the instrument should be bifurcated and accounted for separate from the host agreement pursuant to ASC 815. See DH 3 for more information.

The equity method of accounting does not apply to investments accounted for in accordance with ASC 815. Therefore, the investor should only evaluate those instruments that are not within the scope of ASC 815 to determine whether they represent in-substance common stock of the investee. Put options, call options, and other instruments that are not accounted for pursuant to ASC 815 may meet the characteristics of in-substance common stock.

1.3 Investments in partnerships, joint ventures, and LLCs

In accordance with ASC 323-30-25-1, investors in partnerships, unincorporated joint ventures, and

limited liability companies (LLCs) should generally account for their investment using the equity

method of accounting by analogy if the investor has the ability to exercise significant influence over the

investee. However, there may be situations when significant influence does not exist but the equity

method of accounting applies.

1.3.1 Investments in general partnerships

A general partnership interest in assets, liabilities, earnings, and losses accrues directly to the

individual partners. No “corporate veil” exists between the partners and the related investment.

General partners in a general partnership usually have the inherent right, absent agreements in

partnership articles to the contrary, to influence the operating and financial policies of a partnership.

An interest in a general partnership usually provides an investor with the ability to exercise significant

influence over the operating and financial policies of the investee. As such, assuming an investor does

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not hold a controlling financial interest, a general partnership interest is generally accounted for under

the equity method of accounting.

1.3.2 Limited partnerships and unincorporated joint ventures

Generally, interests in a limited partnership or unincorporated joint venture when the investor does

not have a controlling financial interest would be accounted for under the equity method of accounting

by analogy. ASC 323-30-S99-1 describes the SEC staff’s view on the application of the equity method

to investments in limited partnerships.

This guidance requires a limited partner to apply the equity method of accounting to its investment

unless the limited partner’s interest is so minor that the limited partner has virtually no influence over

the operating and financial policies of the partnership.

An ownership interest greater than 3-5% in certain partnerships, unincorporated joint ventures, and

limited liability companies is presumed to provide an investor with the ability to influence the

operating and financial policies of the investee. This differs from the threshold of 20% of outstanding

voting securities presumed to create influence for an investment in common stock or in-substance

common stock of a corporation. See EM 2.1 for further discussion.

See EM 1.3.3 for guidance on whether a limited liability company should be viewed as a limited

partnership or a corporation for purposes of determining whether the equity method of accounting is

appropriate.

1.3.3 Investments in limited liability companies

Limited liability companies frequently have characteristics of both corporations and partnerships.

Investors must determine whether a limited liability company should be viewed as similar to a

corporation or a partnership for purposes of determining whether its investment should be accounted

for under the equity method of accounting.

Per ASC 323-30-35-3, a noncontrolling investment in a limited liability company that maintains a

specific ownership account (similar to a partnership capital account structure) for each investor

should be viewed similarly to an investment in a limited partnership when determining whether the

investment provides the investor with the ability to influence the operating and financial policies of the

investee.

An investment in a limited liability company that does not maintain specific ownership accounts for

each investor should be viewed similar to an investment in a corporation when determining whether to

apply the equity method of accounting.

1.3.4 Investments in joint ventures

ASC Master Glossary

Joint venture: An entity owned and operated by a small group of businesses (the joint venturers) as a

separate and specific business or project for the mutual benefit of the members of the group. A

government may also be a member of the group. The purpose of a joint venture frequently is to share

risks and rewards in developing a new market, product, or technology; to combine complementary

technological knowledge; or to pool resources in developing production or other facilities. A joint

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venture also usually provides an arrangement under which each joint venturer may participate,

directly or indirectly, in the overall management of the joint venture. Joint venturers thus have an

interest or relationship other than as passive investors. An entity that is a subsidiary of one of the joint

venturers is not a joint venture. The ownership of a joint venture seldom changes, and its equity

interests usually are not traded publicly. A minority public ownership, however, does not preclude an

entity from being a joint venture. As distinguished from a corporate joint venture, a joint venture is

not limited to corporate entities.

Joint ventures are often used to create alliances to enter new markets or expand business operations

while sharing risks and expertise with other investors. Joint ventures are not limited by the type or

legal form of the entity and can be formed as corporations, partnerships, and limited liability

companies. The most distinctive characteristic of a joint venture is the concept of joint control. Refer

to EM 6 for discussion around identifying and accounting for a joint venture.

1.3.5 Trusts that maintain specific ownership accounts

Other entities, such as trusts, can take a variety of forms, and may maintain specific ownership

accounts. When evaluating investments in these entities, it is often appropriate to analogize to the

guidance for limited liability companies (EM 1.3.3) to determine what level of ownership requires the

use of the equity method of accounting. Investors should consider all relevant facts and circumstances.

1.3.6 Investments in low income housing tax credit partnerships

Companies, particularly financial institutions, may invest in limited partnerships or limited liability

companies that operate qualified affordable housing projects or invest in entities that operate qualified

affordable housing projects. These investors earn federal tax credits as the principal return for

providing capital to facilitate the development, construction, and rehabilitation of low-income rental

property. Typically, an investor will account for its interest using the equity method by analogy as the

investor will have a more than minor interest in the limited liability entity. Per ASC 323-740, investors

in these entities may be eligible, subject to meeting a number of criteria, to elect to recognize the

return they receive as a component of income taxes in the income statement under the proportional

amortization method, rather than apply the equity method of accounting.

In order to be eligible for the election (see TX 3.3.8), the investor cannot have the ability to exercise

significant influence over the operating and financial policies of the entity. This is evaluated using the

indicators of significant influence for determining eligibility for the equity method of accounting (see

EM 2.2). However, the general presumptions on voting stock ownership levels are not applicable for

this evaluation (see EM 2.1). Therefore, care should be taken when evaluating the existence of

significant influence for these entities.

Investors that do not qualify for the proportional amortization method (or do not elect to apply it)

would account for their investments in these partnerships under the equity method if the investor has

a more than minor interest in the investee.

1.4 Investments for which the equity method is not applicable

The equity method of accounting does not apply for certain investments as detailed in ASC 323.

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ASC 323-10-15-4

The guidance in this Topic does not apply to any of the following:

a. An investment accounted for in accordance with Subtopic 815-10

b. An investment in common stock held by a nonbusiness entity, such as an estate, trust, or

individual

c. An investment in common stock within the scope of Topic 810

d. Except as discussed in paragraph 946-323-45-2, an investment held by an investment company

within the scope of Topic 946.

ASC 323-30-15-4

This Subtopic does not provide guidance for investments in limited liability companies that are

required to be accounted for as debt securities pursuant to paragraph 860-20-35-2.

Certain investments scoped out of the equity method guidance are discussed in the following sections.

Additionally, equity method is not applied when the fair value option is elected or when the

proportionate consolidation method is used.

1.4.1 Investments in common stock held by a nonbusiness entity

Nonbusiness entities, such as an estate, trust, or an individual, are not required to account for their

investments in common stock under the equity method of accounting even if they are able to exercise

significant influence over the financial and operating policies of the investee. A nonbusiness entity is

not precluded from the use of the equity method if it has significant influence. Rather, this exemption

recognizes the diverse nature of nonbusiness entities and that the use of the measurement alternative

or fair value to recognize these investments may better present the financial position and changes in

financial position of such entities. Nonbusiness entities should consider applying the equity method of

accounting to investments held for long-term operating purposes. However, nonbusiness entities

generally would not use the equity method of accounting to account for portfolio investments.

Real estate investment trusts (REITs) are considered to have business activities, typically by earning

income through real estate loans and investments, and therefore do not qualify for the nonbusiness

entity exception. As a result, investments held by REITs should be analyzed to determine if the equity

method of accounting should be applied.

1.4.2 Investments in common stock within the scope of ASC 810

An investment in common stock that represents a controlling financial interest should be consolidated

pursuant to ASC 810, Consolidation. It would not be appropriate for a reporting entity preparing

consolidated financial statements to account for an investment in common stock that represents a

controlling financial interest under the equity method of accounting. See CG 2 and CG 3 for further

information on the accounting for investments that represent a controlling financial interest under the

VIE and VOE consolidation models, respectively.

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1.4.3 Investment in common stock held by an investment company

An investment held by an investment company, as defined in ASC 946, is required to be accounted for

at fair value, except as described below. Therefore, use of the equity method of accounting by an

investment company is not appropriate, regardless of whether or not the investment company has the

ability to exercise significant influence over the investee.

The one exception to this general principle is when an investment company has an investment in an

operating entity that provides services to the investment company, such as investment advisory or

transfer agent services. The purpose of this type of investment is to provide services to the investment

company and not to realize a gain on the sale of the investment. These types of investments should be

accounted for under the equity method of accounting (not at fair value), provided that the investment

otherwise qualifies for use of the equity method.

1.4.4 Investments in LLCs accounted for as debt securities

An investor may have significant influence over the operating and financial policies of an investee, but

if the investment does not qualify as common stock or in-substance common stock, the application of

the equity method would not be appropriate. Per ASC 860-20, investments in limited liability

companies that can be contractually prepaid or settled in a way that the investor would not recover

substantially all of its recorded investment are accounted for as debt securities under ASC 320. These

types of securities are outside the scope of the equity method.

1.4.5 Equity investments for which the fair value option is elected

ASC 825 permits reporting entities to choose to elect the fair value option at specified election dates

and measure eligible items at fair value.

Excerpt from ASC 825-10-15-4

All entities may elect the fair value option for any of the following eligible items:

a. A recognized financial asset and financial liability…

Equity method investments are financial assets and are generally eligible for the fair value option

under ASC 825-10. However, if the investor’s interest includes a significant compensatory element

(e.g., a performance incentive interest embedded as part of a general partner’s equity interest) and no

bifurcation of the compensatory element is required, the investor is precluded from electing the fair

value option for its equity investment. For example, if an equity investment included a substantive

obligation for the investor to provide services to the investee, the election of the fair value option

would not be appropriate as it could result in the acceleration of revenue that should be earned when

future services are provided to the investee.

An investor electing to adopt the fair value option for any of its equity method investments is required

to present those equity method investments at fair value at each reporting period, with changes in fair

value reported in the income statement. In addition, certain disclosures are required in the investor’s

financial statements when it has elected the fair value option for an investment that otherwise would

be accounted for under the equity method of accounting. See FSP 20.6.3.2 for these disclosure

requirements.

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An investor can generally elect the fair value option for a single eligible investment without needing to

elect the fair value option for identical types of investments in other entities. That is, an instrument-

by-instrument election is permitted. However, when an investor elects the fair value option for a

specific investment, it must apply the fair value option to all of its eligible interests in the same entity

(e.g., all tranches of equity, debt investments, guarantees).

The fair value option can be elected when an investment becomes subject to the equity method of

accounting for the first time. For example, an investment may become subject to the equity method of

accounting for the first time when an investor obtains significant influence by acquiring an additional

investment in an investee or when an investor loses control of an investee, but retains an interest that

provides it with the ability to exercise significant influence.

The election of the fair value option is irrevocable, unless an event creating a new election date occurs.

Therefore, absent a qualifying event, a reporting entity that elects to adopt the fair value option to

account for an equity method investment is precluded from subsequently applying the equity method

of accounting to that investment. An investor that elects the fair value option and subsequently loses

the ability to exercise significant influence would be required to continue to account for its retained

interest on a fair value basis (i.e., the retained investment would not be eligible to be accounted for

pursuant to other GAAP, such as the measurement alternative under ASC 321). See FV 5.4.2 for

further information on qualifying election dates.

1.4.6 The proportionate consolidation method

Proportionate consolidation is appropriate only in limited circumstances and in certain industries.

There is a longstanding practice in the construction and extractive industries of investors displaying

investments in separate unincorporated legal entities (versus an investment in an incorporated entity

or an undivided interest in the separate assets and liabilities) accounted for using the equity method of

accounting on a proportionate gross basis, such that the investor’s financial statements reflect the

investor’s pro rata share of each of the venture’s assets, liabilities, revenues, and expenses (rather than

the one-line treatment) consistent with the guidance in ASC 810-10-45-14. See CG 6.4 for further

details.

Chapter 2: Ability to exercise significant influence

Ability to exercise significant influence

PwC 22-2

2.1 Significant influence presumption

An investor should generally apply the equity method of accounting for investments in common stock

or in-substance common stock of corporations when the investor does not control, but has the ability

to exercise significant influence over the operating and financial policies of the investee.

The significant influence determination requires evaluation of the related facts and circumstances for

each investment, and should be assessed on an ongoing basis. Therefore, an investor’s initial

conclusion regarding significant influence may change. For example, an investee that files for

bankruptcy or becomes subject to significant exchange restrictions or other government controls may

cast doubt on an investor’s ability to exercise significant influence. This could result in a change in the

investor’s conclusion regarding its ability to exercise significant influence.

In addition, the ability to exercise significant influence over an investee is different from the ability to

control an investee. Multiple investors may have the ability to exercise significant influence over the

operating and financial policies of an investee, even in instances when there is one investor with a

controlling financial interest that consolidates the investee.

The voting percentage that is presumed to provide an investor with the required level of influence

necessary to apply the equity method of accounting varies depending on the nature of the investee

(e.g., corporation, partnership). Figure EM 2-1 summarizes voting percentages by type of investee.

These are general guidelines and not bright lines (for example, the difference between a 20% voting

interest in common stock and a 19.9% voting interest would not be considered substantive).

Figure EM 2-1 Voting percentages generally presumed to demonstrate significant influence

Investment in:

Investor does not own a controlling financial interest, but owns: Discussed in:

Common stock 20% or more of the outstanding

voting securities

EM 1.2,

EM 2.1.1

In-substance common stock 20% or more of the outstanding

voting securities

EM 1.2.1,

EM 2.1.1

General partnership interest in a

partnership

Any noncontrolling financial

interest

EM 1.3.1,

EM 2.1.2

Limited partnership or unincorporated

joint venture

3-5% or more of a limited

partnership or other interest1

EM 1.3.2,

EM 2.1.2

Limited liability company or

partnership that does not maintain

specific ownership accounts for each

investor (similar to a corporation)

20% or more of the outstanding

voting securities

EM 1.3.3,

EM 2.1.1


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Investment in:

Investor does not own a controlling financial interest, but owns: Discussed in:

Limited liability company or

partnership that maintains a specific

ownership account for each investor

(similar to a limited partnership)

3-5% or more of the outstanding

voting securities1

EM 1.3.3,

EM 2.1.2

1 Equity method accounting for interests in limited partnerships is generally appropriate unless the interest is so minor that the

investor has virtually no influence (less than 3%). See EM 2.1.2.

2.1.1 Investments in voting common stock or in-substance common stock

The presumption of significant influence is based on ownership of outstanding securities whose

holders have current, not potential, voting privileges. An investor would generally disregard potential

voting privileges that may become available in the future (e.g., call options or convertible

instruments). Also, an investor must consider voting privileges attached to all classes of common

stock, preferred stock, and debentures of the investee. For example, some convertible investments may

allow investors to vote on an as-converted basis. Others may not permit exercise of voting rights until

conversion to common stock. In the second example, those voting rights would not be considered in

assessing the presumption of significant influence as they are not currently exercisable. See CG 3.3 for

further information regarding consideration of potential voting privileges.

While significant influence is presumed to exist for investments of 20% or more of the investee’s

outstanding voting common stock, this can be overcome if there is predominant contrary evidence.

These factors are discussed in EM 2.3. Additionally, an investment of less than 20% of the voting

common stock of an investee, in combination with other indicators (e.g., board representation), could

also provide the investor with the ability to exercise significant influence. See EM 2.2 for further

information.

An investor might be relatively passive and still have the ability to exercise significant influence over

an investee’s operating and financial policies. That is, an investor does not need to actively exercise

and demonstrate such ability. Therefore, it is not appropriate for an investor with an ownership

interest of greater than 20% of the outstanding voting securities of an investee to overcome the

significant influence presumption solely on the basis that it (1) has not historically exercised influence,

and (2) does not intend to influence the investee in the future.

2.1.2 Considerations for limited partnerships and similar entities

Investments in limited partnerships and similar entities (e.g., a limited liability company that

maintains a specific ownership account for each investor) should generally be accounted for under the

equity method of accounting unless the investment is so minor that the limited partner has virtually no

influence over the partnership’s operating and financial policies. In practice, investments exceeding 3

to 5% are viewed as more than minor. This threshold is different than the level applied for an

investment in a corporation (see EM 2.1.1).


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Excerpt from ASC 323-30-S99-1

The SEC staff’s position on the application of the equity method to investments in limited partnerships

is that investments in all limited partnerships should be accounted for pursuant to paragraph 970-

323-25-6. That guidance requires the use of the equity method unless the investor’s interest “is so

minor that the limited partner may have virtually no influence over partnership operating and

financial policies.” The SEC staff understands that practice generally has viewed investments of more

than 3 to 5 percent to be more than minor.

The use of the equity method may be applied in situations when an investor has a less than 3%

investment in an entity that maintains separate ownership accounts for each investor based on facts

and circumstances.

Investments in a limited liability company that does not maintain specific ownership accounts for each

investor (see EM 1.3.3) should be assessed under the guidance discussed in EM 2.1.1 for common stock

and in-substance common stock.

A general partnership interest should be accounted for under the equity method of accounting unless

the investor has a controlling financial interest and is required to consolidate.

2.1.3 Direct and indirect investments

When determining significant influence, investors must consider both direct and indirect investments

(i.e., those that may be held by its other investees) in an investee.

Example EM 2-1, Example EM 2-2, Example EM 2-3, Example EM 2-4, Example EM 2-5, and

Example EM 2-6 illustrate the consideration of direct and indirect investments held by an investor.

EXAMPLE EM 2-1

Investment in each tier qualifies for equity method accounting

Company A owns a 20% voting common stock interest in Company B. Company B owns a 20% voting

common stock interest in Company C. Therefore, Company A indirectly owns 4% of Company C. No

contrary evidence exists to overcome the presumption that Company A has significant influence over

Company B and that Company B has significant influence over Company C. All investors and investees

are corporate entities.

How should Company A and Company B account for their investments?

Analysis

Company B should account for its investment in Company C pursuant to the equity method of

accounting. Company A should account for its investment in Company B pursuant to the equity

method of accounting. Company B would record its proportionate share of the earnings or losses of

Company C in its financial statements before Company A records its proportionate share of the

earnings or losses of Company B in its financial statements.


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EXAMPLE EM 2-2

Investment qualifies for equity method accounting through ownership by commonly controlled

investors

Company A owns an 80% voting common stock interest in Company B and a 70% voting common

stock interest in Company C. Company B and Company C each own a 10% voting interest in Company

D. Company A’s investments in Company B and Company C represent controlling financial interests.

Therefore, Company A consolidates Company B and Company C. All investors and investees are

corporate entities.

How should Company A account for its interest in Company D?

Analysis

Company A’s economic interest in Company D is 15%: an 8% interest through its controlling financial

interest in Company B (80% * 10%) and a 7% interest through its controlling financial interest in

Company C (70% * 10%). However, because Company A controls both Company B and Company C,

Company A would not limit its indirect investment in Company D due to the partial ownership.

Instead, it would be considered to have a 20% voting interest in Company D (10% through its control

of Company B and 10% through its control of Company C).

Therefore, Company A’s indirect ownership interest in Company D, absent evidence to the contrary, is

presumed to provide it with the ability to exercise significant influence over Company D. Therefore, if

the presumption is not overcome, Company A should account for its investment in Company D under


In their standalone financial statements, Company B and Company C would separately evaluate

whether they have the ability to exercise significant influence over Company D. Given their parent

(Company A) controls 20% of Company D’s voting stock, Company B and C would generally conclude

in their separate financial statements that they have significant influence over Company D.

EXAMPLE EM 2-3

Equity method accounting despite majority interest through direct and indirect interests

Company A owns a 40% voting common stock interest in each of Company B and Company C.

Company B also owns a 30% voting common stock interest in Company C. The remaining interests in

Company B and Company C are widely held by other investors and there are no other agreements that

affect the voting or management structures of Company B and Company C. All investors and investees

are corporate entities. Company C is not a VIE.


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How should Company A account for its direct and indirect interests in Company C?

Analysis

As there are no other agreements that affect the voting or management structures of Company B and

Company C, Company A’s interest in Company B is not sufficient to direct the actions of Company B’s

management. This includes how Company B should vote its 30% interest in Company C. Therefore,

despite its 52% economic interest in Company C (40% direct interest, plus its 12% indirect interest

through Company B (40% * 30%)), Company A would not consolidate Company C in its financial

statements. Instead, Company A would account for its investment in Company C under the equity

method of accounting.

EXAMPLE EM 2-4

Investment in investee and direct investment in investee’s consolidated subsidiary

Company A owns a 25% voting common stock interest in Company B, which is accounted for under the

equity method of accounting. Company A also owns a 15% voting common stock interest in Company

C. Company B owns an 80% voting common stock interest in Company C, which provides Company B

with a controlling financial interest; therefore, Company B consolidates Company C. All investors and

investees are corporate entities.

How should Company A account for its direct interest in Company C?

Analysis

Company A has the ability to exercise significant influence over Company B. Company B has control

over Company C; therefore, through its ability to exercise significant influence over Company B,

Company A also has the ability to exercise significant influence over Company C, despite only having a

15% direct interest. As such, Company A should account for its direct investment in Company C under



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EXAMPLE EM 2-5

Equity method accounting through direct and indirect interests

Company A owns 50% of the voting common stock of Company B and applies the equity method of

accounting since it has significant influence over Company B. Company B owns 22% of the voting

common stock of Company C and applies the equity method of accounting since it has significant

influence over Company C. Company A owns (directly) 7% of the voting common stock of Company C.

All investors and investees are corporate entities.

How should Company A account for its direct investment in Company C?

Analysis

Company A’s economic interest in Company C is 18% (7% direct interest plus its 11% indirect interest

(50% * 22%)). Given that Company A has the ability to exercise significant influence over the

operating and financial policies of Company B (including Company B’s investment in Company C),

Company A would apply the equity method of accounting to its 7% direct investment in Company C.

EXAMPLE EM 2-6

Investment may not qualify for equity method of accounting despite an economic interest of 20%

Company A owns a 40% voting common stock interest in Company B, which is accounted for under

the equity method of accounting. Company A also owns a 16% voting common stock interest in

Company C. Company B owns a 10% voting common stock interest in Company C. Individually,

Company A and Company B are not able to exercise significant influence over the operating and

financial policies of Company C. All investors and investees are corporate entities.

How should Company A account for its direct and indirect interests in Company C?


2-8

Analysis

Company A’s economic interest in Company C is 20% (16% direct interest, plus its 4% indirect interest

(40% * 10%)). As neither Company A nor Company B have the ability to exercise significant influence

over the operating and financial policies of Company C individually, Company A’s 20% economic

interest in Company C is not, in and of itself, sufficient to indicate that it has the ability to exercise

significant influence over Company C. Absent other factors that indicate that Company A has the

ability to exercise significant influence over Company C (e.g., Company A having representation on

Company C’s board), the equity method of accounting would not be appropriate for Company A’s

investment in Company C.

2.2 Other indicators of significant influence

The determination of significant influence is not limited to the evaluation of voting interests and the

level of ownership interest an investor holds. An investor must consider all relationships and interests

(voting and nonvoting) in an investee, including any means through which the investor might

influence the operating and financial policies of an investee. Examples include board representation,

veto rights, or participating rights conveyed by a security other than voting common stock. An investor

should also consider the capitalization structure of the investee, how significant its investment is to the

investee’s capitalization, and the rights and preferences of other investors.

ASC 323-10-15-6 provides a list of indicators that investors should consider when evaluating whether

or not it has the ability to exercise significant influence over the operating and financial policies of an

investee.

ASC 323-10-15-6

Ability to exercise significant influence over operating and financial policies of an investee may be

indicated in several ways, including the following:

a. Representation on the board of directors

b. Participation in policy-making processes

c. Material intra-entity transactions

d. Interchange of managerial personnel

e. Technological dependency

f. Extent of ownership by an investor in relation to the concentration of other shareholdings (but

substantial or majority ownership of the voting stock of an investee by another investor does not

necessarily preclude the ability to exercise significant influence by the investor).

The list of factors in ASC 323-10-15-6 is not all-inclusive, and the determination of whether other

factors provide an investor with the ability to exercise significant influence over the financial and

operating policies of an investee requires significant judgment and consideration of all relevant facts

and circumstances.


2-9

2.2.1 Representation on the board of directors

An investor that has representation on the board of directors can influence the operating and financial

policies of an investee through its presence and participation at the board of directors meetings. An

investor may conclude that the combination of board representation, with a less than 20% investment

in the voting common stock of an investee, may result in significant influence. Specific consideration

should be given to board representation that is disproportionate to an investor’s ownership interest in

the voting securities of the investee. Example EM 2-7 illustrates how significant influence may be

demonstrated through representation on the board of directors.

EXAMPLE EM 2-7

Representation on the board of directors

Investor has a 19.5% ownership interest in the voting common stock of Investee. Investor also holds

one of five seats on Investee’s board of directors. There are no other indicators that Investor has the

ability to exercise significant influence over the operating and financial policies of Investee.

Does Investor have the ability to exercise significant influence over the operating and financial policies

of Investee?

Analysis

Investor is likely to conclude that the combination of its voting common stock ownership interest and

its representation on the board of directors provides it with the ability to exercise significant influence

over the operating and financial policies of Investee. Careful consideration should be given whenever

an investor has an ownership interest of less than 20% and investee board representation. The number

of representatives and the size of the board are important considerations when determining whether

the equity method of accounting is appropriate.

2.2.2 Participation in policy-making processes

An investor should evaluate its ability to participate in the operating and financial decision making of

the investee through voting rights, veto rights, or other participating rights or arrangements. For

example, in some cases, investors attend board of directors meetings in an “observer” capacity. While

observers usually do not vote with the board, attendance alone may provide the investor with the

ability to exercise influence as the investor is able to obtain confidential materials and participate in

discussions at the board meetings. Therefore, investors should evaluate whether an observer seat at

board of directors meetings provide it with the ability to exercise significant influence. Example EM 2-

8 illustrates how participation in policy-making processes should be considered in assessing

significant influence.

EXAMPLE EM 2-8

Significant influence consideration of observer seat on the board of directors

Investor owns a less than 20% ownership interest in the voting common stock of Investee. Investor

also has an observer seat on the board of directors. There are no other indicators that Investor has the

ability to exercise significant influence over the operating and financial policies of Investee.


2-10


of Investee?

Analysis

Investor’s observer seat on the board of directors usually provides an investor with the ability to

exercise some level of influence over policy making. As such, Investor should consider whether the

combination of its voting common stock ownership interest and its observer seat on the board of

directors provide it with the ability to exercise significant influence.

2.2.3 Material intra-entity transactions

An investor may enter into material transactions with an investee that may provide the investor with

the ability to exercise significant influence. The related facts and circumstances should be evaluated.

For example, routine intra-entity transactions, such as purchases and sales of non-specialized

inventory (e.g., commodity inventories), may not provide an investor with the ability to exercise

significant influence, even if those transactions are material. Interchange of managerial personnel

Key members of management at an investor may serve in significant management roles (e.g., CEO,

CFO) at the investee level. Investor employees serving in such roles at the investee level may provide

an investor with the ability to exercise significant influence over the operating and financial policies of

the investee. However, consideration should be given to the level of responsibilities of the employees

as well as potential oversight and control by the investee board of directors (while considering any

common directors with the investor board of directors).

2.2.4 Technological dependency

An investee may be technologically dependent upon an investor in the operation of its business. This

technological dependence may provide the investor with the ability to exercise significant influence,

even if the investor’s ownership interest in the voting common stock of investee is less than 20%.

Example EM 2-9 illustrates how significant influence may be demonstrated through technological

dependency.

EXAMPLE EM 2-9

Significant influence consideration of technological dependency

Investor owns a less than 20% voting interest in Investee. Investee’s operations are dependent upon a

type of technology that is licensed to it by Investor. Investee could license similar technology from a

small number of other companies. However, Investee would incur significant termination fees, higher

licensing fees, and significant effort to incorporate the alternative technology into its operations.


of Investee?

Analysis

Investor should consider whether the combination of its voting interest and its licensing agreement

provides it with the ability to exercise significant influence over the operating and financial policies of


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Investee. Investee is dependent upon Investor’s technology and would have to incur significant costs

and effort to choose an alternative technology supplier. Therefore, Investor may have significant

influence over Investee through a combination of its equity interest and licensing agreement.

2.2.5 Ownership in relation to the concentration of other shareholdings

An investor should consider the extent of its ownership interest in an investee in relation to the

ownership interests held by other investors. There may be a few investors, each with significant voting

interests in an investee or interests in an investee may be more widely held, with no single investor

holding a significant voting interest.

An investor that holds a substantial or majority ownership interest in the voting stock of an investee

does not preclude another investor from having the ability to exercise significant influence. For

example, absent predominant evidence to the contrary (see EM 2.3), an investor that owns a 25%

voting interest in an investee is presumed to have the ability to exercise significant influence, even if a

single investor owns the remaining 75% voting interest in the investee.

An investor that holds a less than 20% voting interest may be able to demonstrate significant influence

in a widely-held investee when all other investors, individually, have substantially smaller ownership

interests. Judgment will need to be applied.

2.3 Predominant evidence to the contrary

As discussed in EM 2.1, there’s a presumption that an investor has the ability to exercise significant

influence when it owns (directly or indirectly) 20% or more of the outstanding voting common stock or

in-substance common stock of an investee. However, ASC 323-10-15-10 provides a list of indicators

(not all-inclusive) that an investor may be unable to exercise significant influence, despite an

ownership interest of greater than 20% of the outstanding voting common stock.

ASC 323-10-15-10

Evidence that an investor owning 20 percent or more of the voting stock of an investee may be unable

to exercise significant influence over the investee’s operating and financial policies requires an

evaluation of all the facts and circumstances relating to the investment. The presumption that the

investor has the ability to exercise significant influence over the investee’s operating and financial

policies stands until overcome by predominant evidence to the contrary. Indicators that an investor

may be unable to exercise significant influence over the operating and financial policies of an investee

include the following:

a. Opposition by the investee, such as litigation or complaints to governmental regulatory

authorities, challenges the investor’s ability to exercise significant influence.

b. The investor and investee sign an agreement (such as a standstill agreement) under which the

investor surrenders significant rights as a shareholder. (Under a standstill agreement, the investor

usually agrees not to increase its current holdings. Those agreements are commonly used to

compromise disputes if an investee is fighting against a takeover attempt or an increase in an

investor’s percentage ownership. Depending on their provisions, the agreements may modify an

investor’s rights or may increase certain rights and restrict others compared with the situation of

an investor without such an agreement.)


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c. Majority ownership of the investee is concentrated among a small group of shareholders who

operate the investee without regard to the views of the investor.

d. The investor needs or wants more financial information to apply the equity method than is

available to the investee’s other shareholders (for example, the investor wants quarterly financial

information from an investee that publicly reports only annually), tries to obtain that information,

and fails.

e. The investor tries and fails to obtain representation on the investee’s board of directors.

ASC 323-10-15-11

The list in the preceding paragraph is illustrative and is not all-inclusive. None of the individual

circumstances is necessarily conclusive that the investor is unable to exercise significant influence over

the investee’s operating and financial policies.

However, if any of these or similar circumstances exists, an investor with ownership of 20 percent or

more shall evaluate all facts and circumstances relating to the investment to reach a judgment about

whether the presumption that the investor has the ability to exercise significant influence over the

investee’s operating and financial policies is overcome. It may be necessary to evaluate the facts and

circumstances for a period of time before reaching a judgment.

There are other indicators that may provide predominant evidence to overcome the presumption of

significant influence. For example, if an investor owns a 20% interest in a foreign investee that

operates in a country that has imposed exchange restrictions or in a market that creates other

significant uncertainties, the investor may not be able to exercise significant influence.

Additionally, no individual circumstance is necessarily conclusive that an investor is unable to exercise

significant influence over an investee’s operating and financial policies. As stated in ASC 323-10-15,

predominant evidence is necessary to overcome the presumption of significant influence. An

evaluation of all related facts and circumstances is required.

Example EM 2-10 and Example EM 2-11 illustrate the evaluation of whether contrary evidence exists

to overcome the presumption of an investor’s ability to exercise significant influence over the

operating and financial policies of an investee.

EXAMPLE EM 2-10

Contrary evidence not sufficient to overcome presumption

Investor owns a 25% voting interest in Investee. Investor is a passive investor and has not exercised its

ability to influence the operating and financial policies of Investee in the past. Further, Investor does

not intend to influence the operating and financial policies of Investee in the future. No other contrary

evidence exists to overcome the presumption of significant influence.

Is there predominant evidence to the contrary to overcome the presumption that Investor has the

ability to exercise significant influence over the operating and financial policies of Investee?


2-13

Analysis

The fact that Investor (1) has not exercised its ability to influence Investee in the past and (2) does not

intend to influence Investee in the future is not considered contrary evidence to overcome the

presumption that Investor has the ability to exercise significant influence.

EXAMPLE EM 2-11

Contrary evidence exists to overcome presumption

Investor owns a 20% voting interest in Investee. The majority ownership of Investee is concentrated

among a small group of shareholders who operate Investee without regard to the views of Investor.

Investor has tried unsuccessfully to obtain representation on the Investee’s board of directors.

Investee has actively and publicly resisted the exercise of influence by Investor.

Is there sufficient evidence to the contrary to overcome the presumption that Investor has the ability

to exercise significant influence over the operating and financial policies of Investee?

Analysis

Investor may be able to conclude that there is predominant evidence to overcome the presumption

that it has the ability to exercise significant influence as a result of (1) the small group of shareholders

that own a majority ownership interest in Investee operating Investee without regard to the views of

Investor, (2) Investor’s failed attempts to obtain representation on the Investee’s board of directors,

and (3) Investee’s active and public resistance to the exercise of influence by Investor. Investor should

evaluate all other facts and circumstances relating to the investment.

Chapter 3: Initial measurement of equity method investments

Initial measurement of equity method investments

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3.1 Overview of the initial measurement of equity method investments

A reporting entity will initially measure and recognize its equity method investment using a

cost accumulation model, following the asset acquisition guidance in ASC 805-50-30. The

investment should be presented on the investor’s balance sheet as a single amount, as

described in FSP 10.3.

The investor’s cost of the investment will generally differ from the investor’s proportionate

share of the net assets of the investee. More specifically, the investor’s initial carrying amount

will reflect its cost to acquire the investment, while the investee continues to carry the

underlying assets and liabilities based on its historical application of GAAP. Therefore, to

properly account for its investment, an investor will need to determine and track the

difference between its own carrying amount in the underlying assets and liabilities, and those

of the investee, commonly referred to as basis differences.

An investor’s previously held ownership percentage in an investee may change. Alternatively,

an investor may be required to apply the equity method to a previously owned investment

even when its percentage ownership interest does not change, such as when it gains significant

influence. See EM 5 for a discussion of how to apply the equity method when an investor had a

prior interest in the investee.

3.2 Initial measurement of equity method investment

When an investor acquires an equity method investment for a fixed amount of cash, the cost of

the investment is straightforward and reflects the cash transferred to the seller in return for

the equity method investment, as described in ASC 323-10-30-2. Often, however, a

transaction includes transaction costs, contingent consideration, or other items that warrant

further consideration to determine the cost of the investment, as described in the following

subsections.

When cash is used to acquire an equity method investment, the investor should recognize the

equity method investment at the point at which it acquires both (1) the common stock (or

in-substance common stock), as discussed in EM 1.2 and (2) the ability to exercise significant

influence, as discussed in EM 2.

When noncash consideration is used to acquire an equity method investment, the investor

should evaluate what it transferred to the seller, or contributed to the investee, in return for its

interest in order to determine the point at which the equity method investment should be

recognized, as further described in EM 3.2.4.

3.2.1 Transaction costs to obtain an equity method investment

The initial measurement of an equity method investment should include the cost of the

investment itself and all direct transaction costs incurred by the investor in order to acquire

the investment.


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Direct transaction costs are generally out-of-pocket costs directly associated with the

acquisition of an investment and paid to third parties. Examples of direct transaction costs

include appraisal fees (e.g., fees paid to third party valuation specialist to assist management

in determining whether to invest in an investee and to determine its fair value), legal and

consulting fees (e.g., fees paid to external legal counsel to draft and review investment

agreements in order to consummate the transaction), and finder’s fees (e.g., fees paid to a

broker to identify and facilitate the acquisition of an interest in the investee). All costs that are

not directly associated with the acquisition of an investment, including all internal costs,

should be expensed as incurred. Costs associated with financing the acquisition, such as debt

or equity issuance costs, would not be considered direct costs and would be accounted for in

accordance with other applicable guidance. See FG 1.2.2 and FG 7.4.2.

Costs incurred by the investor on behalf of the investee may not be part of the cost of

the investment. See EM 4.3.7 for a discussion of stock compensation costs that should be

viewed as those of the investee.

The treatment of transaction costs incurred in connection with the acquisition of an equity

method investment is different than the treatment of such costs incurred in connection with

the acquisition of a business, which are required to be expensed as incurred pursuant to ASC

805. See BCG 2 for further information regarding business combinations.

3.2.2 Contingent consideration

In some situations, an investor and the seller of an equity interest may be unable to agree on

the value of the investee, and therefore tie a portion of the consideration to future events or

conditions. Contingent consideration represents an obligation of the investor to transfer

additional cash, noncash assets, or equity interests to the selling shareholders if future events

occur or conditions are met.

If contingent consideration is recognized by the investor, it will increase the carrying amount

of the equity method investment, and result in the recognition of an obligation.

Contingent consideration should only be recognized when:

a) recognition is required by specific authoritative guidance other than ASC 805, or

b) the fair value of the investor’s share of the investee’s net assets exceeds the investor’s

initial cost.

The contingent consideration guidance for an equity method investment is described in ASC

323 and the following subsections, and is different from the contingent consideration

guidance for business combinations (see BCG 2).

ASC 323-10-25-2A

If an equity method investment agreement involves a contingent consideration arrangement

in which the fair value of the investor’s share of the investee’s net assets exceeds the investor’s

initial cost, a liability shall be recognized.


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ASC 323-10-30-2A

Contingent consideration shall only be included in the initial measurement of an equity

method investment if it is required to be recognized by specific authoritative guidance other

than Topic 805.

ASC 323-10-30-2B

A liability recognized under paragraph 323-10-25-2A shall be measured initially at an amount

equal to the lesser of the following:

(a) The maximum amount of contingent consideration not otherwise recognized

(b) The excess of the investor’s share of the investee’s net assets over the initial cost

measurement (including contingent consideration otherwise recognized).

3.2.2.1 Contingent consideration recognized under other guidance

If contingent consideration is required to be recognized by specific authoritative guidance

other than ASC 805 (e.g., ASC 480, Distinguishing Liabilities from Equity, ASC 450,

Contingencies, ASC 610-20, Gains and Losses from the Derecognition of Nonfinancial Assets,

or ASC 815, Derivatives and hedging), it should be recognized in accordance with that

guidance and recorded as part of the cost of the equity method investment.

If the contingent consideration is a derivative within the scope of ASC 815, it would be initially

recorded at fair value, which would be included in the carrying amount of the equity method

investment. The derivative would, however, represent a separate unit of account from the

equity method investment. Accordingly, subsequent changes in the fair value of the derivative

should be recorded in the income statement and not as an increase or decrease to the carrying

amount of the equity method investment. See DH 2 for the characteristics of a derivative

instrument.

Example EM 3-1 illustrates the accounting for contingent consideration that meets the

definition of a derivative.

EXAMPLE EM 3-1

Contingent consideration recognized pursuant to ASC 815

Investor acquired a 20% interest in the voting common stock of Investee for cash

consideration of $100 and a contingent consideration arrangement meeting the definition of a

derivative with a fair value of $10. Investor’s interest in Investee provides it with the ability to

exercise significant influence over the operating and financial policies of Investee. Therefore,

Investor accounts for its investment in Investee pursuant to the equity method of accounting.

At what amount should Investor’s investment in the common stock of Investee be measured

on the date of acquisition?


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Analysis

The contingent consideration arrangement is required to be recognized pursuant to ASC 815.

Therefore, the initial cost of Investor’s investment should be measured at $110 ($100 (cash

consideration) plus $10 (fair value of derivative)). Subsequent changes in the fair value of the

contingent consideration would be accounted for pursuant to ASC 815 and would not affect

the carrying value of the equity method investment.

3.2.2.2 Contingent consideration recognized based on fair value

In some situations, the fair value of the investor’s share of the investee’s net assets is greater

than its initial cost, which would include the consideration initially transferred and any

contingent consideration recognized under other guidance. In these cases, ASC 323-10-30-2B

requires that the investor recognize a liability equal to the lesser of the following:

□ The maximum amount of contingent consideration not otherwise recognized, and

□ The excess of the investor’s share of the investee’s net assets over the initial cost

measurement (including contingent consideration otherwise recognized).

While not explicit in the guidance, we believe that “excess of the investor’s share of the

investee’s net assets” should be understood as the excess of the investor’s share in the fair

value of the investee’s net assets. In determining the fair value of the investee’s net assets, the

investor should include only the identifiable net assets and should not consider the fair value

of the overall investment, which might include implied goodwill.

If contingent consideration is recognized based on this guidance, upon resolution of the

contingency, the carrying amount of the investment should be adjusted to reflect the ultimate

settlement amount. Accordingly, if the consideration paid exceeds the liability initially

recorded, that amount should be recognized as an additional cost of the investment.

Alternatively, if the consideration paid is less than the liability initially recorded, the difference

should reduce the cost of the investment.

ASC 323-10-35-14A

If a contingency is resolved relating to a liability recognized in accordance with the guidance in

paragraph 323-10-25-2A and the consideration is issued or becomes issuable, any excess of

the fair value of the contingent consideration issued or issuable over the amount that was

recognized as a liability shall be recognized as an additional cost of the investment. If the

amount initially recognized as a liability exceeds the fair value of the consideration issued or

issuable, that excess shall reduce the cost of the investment.

Example EM 3-2 illustrates the recognition of contingent consideration when the fair value of

the investor’s share of the investee’s net assets exceeds the investor’s initial cost.


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EXAMPLE EM 3-2

Contingent consideration when the fair value of the Investor’s share of the Investee’s net

assets exceeds the investor’s initial cost

On January 1, 20X0, Investor acquired a 20% interest in the voting common stock of Investee

for cash consideration of $100. On the date of acquisition, the fair value of Investor’s share of

the Investee’s net assets was $120. Investor is required to pay additional consideration of $25

to Investee if certain performance targets are met. Contingent consideration was not required

to be recorded upon acquisition pursuant to other specific authoritative guidance (e.g., ASC

450).

At what amount should Investor’s investment in the common stock of Investee be measured

on the date of acquisition?

Analysis

The investor should record a liability for the contingent consideration equal to the lesser of

(1) the maximum amount of contingent consideration not otherwise recognized, which is $25

and (2) the excess of the fair value of Investor’s share of the Investee’s net assets over the cost

of Investor’s investment of $20 ($120 – $100).

As such, Investor should initially record its investment in the common stock of Investee at

$120 and would recognize a liability of $20. When the contingency is resolved, the difference

between the contingent consideration liability recorded at the acquisition date (i.e., $20) and

the consideration paid should be recorded as an increase or decrease to the carrying amount

of the equity method investment.

3.2.3 Guarantee issued by investor on behalf of equity method investee

An investor may issue a guarantee to a third party on behalf of an equity method investee. In

such situations, the investor should consider the guidance in ASC 460, Guarantees, and if

applicable record a liability to reflect its obligation.

Although a parent’s guarantee of its subsidiary’s debt is not subject to ASC 460, as noted in

ASC 460-10-25-1(g), an investor’s guarantee of the debt of an equity method investee is

subject to that guidance as the equity method investee is not a subsidiary.

ASC 460-10-25-4

At the inception of a guarantee, a guarantor shall recognize in its statement of financial

position a liability for that guarantee. This Subsection does not prescribe a specific account for

the guarantor’s offsetting entry when it recognizes a liability at the inception of a guarantee.

That offsetting entry depends on the circumstances in which the guarantee was issued. See

paragraph 460-10-55-23 for implementation guidance.


Although paragraph 460-10-25-4 does not prescribe a specific account, the following illustrate

a guarantor’s offsetting entries when it recognizes the liability at the inception of the

guarantee:

…


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a. If the guarantee were issued in conjunction with the formation of a partially owned

business or a venture accounted for under the equity method, the recognition of the

liability for the guarantee would result in an increase to the carrying amount of the

investment.

If an investor issued a guarantee in connection with the formation of the equity method

investment, or provided the guarantee as part of consideration transferred to the investee in

return for the shares, the guarantee should be viewed as part of the total consideration

provided in return for the investment. Accordingly, the recognized guarantee would be

reflected as an increase to the carrying value of the investment.

After the initial recognition of the guarantee, all subsequent accounting for the guarantee

would be in accordance with ASC 460, and therefore would not impact the carrying amount of

the equity method investment.

If a guarantee is issued by the investor after the formation of the equity method investment,

see EM 4.5.

3.2.4 Noncash assets used to acquire an equity method investment

Investors may transfer noncash assets in exchange for an equity interest in an investee.

The counterparty may be another investor that is selling its interest in the investee, or may be

the investee itself issuing interests to the investor. For situations in which an investor had a

prior interest in the investee, see EM 5.

When noncash assets are used to acquire an equity method investment, the equity method

investment is recognized when the noncash assets are derecognized, which is generally once

control has been transferred. Noncash assets can be either financial assets or nonfinancial

assets and the determination of when control has transferred depends on the type of noncash

assets transferred. When nonfinancial assets are transferred, the guidance discussed in PPE

6.2 and illustrated in Figure PPE 6-1 should be followed. When financial assets are

transferred, the guidance in ASC 860 (discussed in TS 3) should be followed. If those financial

assets are equity method investments, see EM 3.2.4.1.

3.2.4.1 Exchange of an equity method investments

ASC 860 establishes accounting and reporting standards for transfers and servicing of

financial assets. Equity method investments are financial assets; therefore, transfers of equity

method investments are within the scope of ASC 860 provided they meet the definition of a

transfer, as defined in ASC 860.

Definition from ASC 860-10-20

Transfer: The conveyance of a noncash financial asset by and to someone other than the issuer

of that financial asset.

The implementation guidance in ASC 845-10-55-2 (related to nonmonetary transactions) also

confirms that the exchange of one equity method investment for another equity method

investment must be accounted for pursuant to the guidance in ASC 860.


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Accordingly, the sale of investee shares accounted for under the equity method of accounting

must meet all of the criteria in ASC 860-10-40-5 in order to qualify for derecognition and to

recognize the associated gain or loss. This guidance is further explained in TS 3.

Provided the criteria are met, the full gain or loss would be recognized for the difference

between the carrying amount of the equity method investment that is surrendered and the

consideration received (i.e., the fair value of the equity method investment that is obtained) as

described in the equity method guidance in ASC 323-10-35-35 and the transfers guidance

referenced in TS 4.2.

Example EM 3-3 illustrates the accounting for an exchange of equity method investments

under ASC 860.

EXAMPLE EM 3-3

Exchange of one equity method investment for another equity method investment accounted

for as a sale pursuant to ASC 860

Investor A has a 20% investment in Investee, an operating company that manufactures and

sells airplanes. The carrying value of Investor’s A interest is $400. Investor accounts for its

investment in Investee using the equity method. Assume no basis difference exists between

Investor A’s investment balance and its underlying interest in the net assets of Investee (i.e.,

both are $400).

Acquiror LP, which manufactures and sells speed boats and off-road vehicles, acquires the

20% interest held by Investor A by providing Investor A with a 4% equity interest in Acquiror

LP. The fair value of the 4% interest in Acquiror LP is $2,000.

How should Investor A account for its exchange of a 20% interest in Investee for a 4% interest

in Acquiror LP?

Analysis

Investor A should account for this exchange under ASC 860, and recognize a gain on the sale

of its equity interest in Investee once it meets the criteria for derecognition. The gain will be

$1,600 (the difference between the $2,000 selling price and the $400 carrying value of the

interest sold at the time of sale). Investor A’s cost basis in its investment in Acquiror LP would

be $2,000. Prospectively, Investor A would account for its 4% interest in Acquiror LP under

the equity method of accounting (see EM 2.1.2).

In certain circumstances, the exchange of one equity method investment for another equity

method investment may in substance be a change in interest transaction (i.e., a change in the

percentage ownership of one investment), and not the exchange of one investment for

another. This is illustrated in Example EM 3-4, where the exchange of interests is in substance

a dilution event. In such situations, the issuer (investee) is deemed to have effectively issued

additional shares to other investors and the change in interest guidance discussed in EM

5.4.2.2 would be applied.


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In practice, judgment must be applied in determining whether an exchange of equity method

investments should be accounted for as a sale as illustrated in Example EM 3-3, or a change in

interest transaction, as illustrated in Example EM 3-4.

EXAMPLE EM 3-4

Exchange of one equity method investment for another equity method investment accounted

for as a change in interest transaction

Investors A, B, and C own the following interests in Investee, an operating company that

manufactures and sells goods:

Shareholder Shares Percent

ownership Carrying value of

underlying net assets

Investor A 40 40% $400

Investor B 30 30% 300

Investor C 30 30% 300

Total 100 100% $1,000

Assume no basis difference exists between Investor A’s investment balance and its underlying

interest in the net assets of Investee (i.e., both are $400). Investors A, B, and C created a new

company (“Newco”), which had no assets, liabilities, or operations immediately subsequent to

formation. Newco issued 15 shares (15% interest) to each of Investors D and E in exchange for

$1,500. The proceeds will be used to fund Newco’s operations. At the same time, Investors A,

B, and C exchange their equity interests in Investee for equity interests in Newco. Investors A,

B, and C receive 28, 21, and 21 shares in Newco, respectively. Immediately after these

transactions, the shareholdings of Newco are as follows.

Shareholder Shares Percent

ownership

Carrying value of underlying net assets, prior

to change in interest computation

Fair value

Investor A 28 28% $400 $2,800

Investor B 21 21% 300 2,100

Investor C 21 21% 300 2,100

Investor D 15 15% 1,500 1,500

Investor E 15 15% 1,500 1,500

Total 100 100% $4,000 $10,000


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How should Investor A account for its exchange of a 40% interest in Investee for a 28%

interest in Newco?

Analysis

Newco is effectively the same business as that of Investee because Newco has no additional

assets, liabilities, or operations, except for the cash paid by Investors D and E to obtain 15%

ownership interests in Newco. Therefore, Investor A has an investment in the same underlying

business both before and after the transaction; however, its ownership interest has been

diluted by virtue of Newco’s issuance of shares to Investors D and E for cash. As such, Investor

A should account for this exchange as a change in interest transaction. As further explained in

EM 5.4.2.2, Investor A should recognize a change in interest gain of $720, calculated as the

difference between (a) Investor A’s proportionate share of Newco’s new carrying value (28% x

$4,000 = $1,120) and (2) the carrying value of Investor A’s ownership interest in the Investee

prior to the transaction ($400). This would result in a gain of $720 ($1,120-$400).

Investor A’s change in interest gain can also be calculated as follows:

Fair value per share $100.00 a

Investor A’s carrying value per share 14.29 b

Excess paid over carrying value per share 85.71

Shares issued to Investors D and E by Newco x 30

Total excess paid over carrying value 2,571

Investor A’s % ownership in Newco x 28%

Investor A’s change in interest gain $720

a – Investors D and E each paid $1,500 in exchange for 15 shares, or $100 per share.

b – Prior to Newco’s issuance of shares to Investors D and E, Investor A held 28 shares of

Newco with a carrying value of $400, or $14.29 per share.

Investor A’s cost basis in its continuing investment in Newco is $1,120 (28% of $4,000).

3.3 Allocating the cost basis to assets and liabilities

Although an equity method investment is presented on the balance sheet of the investor as a

single amount, the underlying accounting for the investment is similar to how an entity would

account for a consolidated subsidiary. That is, an investor must allocate the initial cost of its

equity method investment to its proportionate share of the individual assets and liabilities of

the investee.


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ASC 323-10-35-13

A difference between the cost of an investment and the amount of underlying equity in net

assets of an investee shall be accounted for as if the investee were a consolidated subsidiary…

ASC 323-10-35-34

The carrying amount of an investment in common stock of an investee that qualifies for the

equity method of accounting as described in paragraph 323-10-15-12 may differ from the

underlying equity in net assets of the investee. The difference shall affect the determination of

the amount of the investor's share of earnings or losses of an investee as if the investee were a

consolidated subsidiary. However, if the investor is unable to relate the difference to specific

accounts of the investee, the difference shall be recognized as goodwill and not be amortized in

accordance with Topic 350.

3.3.1 Determination of basis differences

While the investor’s initial carrying amount of an equity method investment will reflect its cost

of the investment, the investee carries the underlying assets and liabilities utilizing its own

historical cost basis. Therefore, a difference will usually exist between (a) the carrying value of

the investment and (b) the investor’s proportionate share of the carrying amount of the

investee’s net assets.

The investor should use its own cost basis in the investee, rather than the investee’s basis in its

own assets and liabilities to record the equity method investment.

Application of the guidance in ASC 323-10-35-13 requires that the investor account for the

basis adjustments as if the subsidiary was a consolidated subsidiary in memo accounts.

Accordingly, the investor must determine its cost basis in the individual assets and liabilities

of the investee, including those assets and liabilities not recorded in the investee’s general

ledger (e.g., unrecognized intangible assets), similar to how the acquisition method is applied

in a business combination. The difference between the cost of an investment and the investor’s

share of the net assets as recognized by the investee is generally attributable to multiple assets

and liabilities of the investee.

While assets that have appreciated will have a positive basis difference (i.e., the investor’s

basis will be greater than that of the investee), basis differences can be either positive

or negative.

As illustrated in Example EM 3-3 and Example EM 3-4, subsequent to acquisition, basis

differences assigned to identified assets and liabilities will often impact earnings, with a

corresponding increase or decrease to the equity investment balance.

See BCG 2 for general information on the application of the acquisition method. See EM 3.3.4

for a discussion of the deferred tax implications of these basis differences. See EM 4.3.1 for

further information on the subsequent accounting for the basis differences identified.

An investor, through its ability to exercise significant influence over the investee, will generally

be able to obtain sufficient financial data to determine the primary assets and liabilities giving

rise to a basis difference. In the unusual circumstance when an investor is unable to do so, the

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inability to obtain such information from the investee must be reconciled with the conclusion

that the investor has the ability to exercise significant influence over the operating and

financial policies of the investee.

Example EM 3-5 illustrates the assignment of a positive basis difference on the date of

acquisition when the positive basis difference is attributable to one asset. Example EM 3-6

illustrates the assignment of a negative basis difference on the date of acquisition when the

negative basis difference is attributable to one asset. For purposes of each example,

transaction costs and tax implications are ignored.

EXAMPLE EM 3-5

Accounting for a positive basis difference on the date of acquisition

Investor purchased a 40% interest in the voting common stock of Investee for $56 million.

Investor determined that it has the ability to exercise significant influence over the operating

and financial policies of Investee. Therefore, Investor accounts for its interest in Investee

under the equity method.

Investor engaged a third-party valuation firm to perform a fair value assessment of Investee’s

fixed assets and determined that the fair value was $90 million. Investor also concluded that

Investee’s carrying value of its current assets was representative of fair value.

At the date of acquisition, Investee’s assets and liabilities are as follows (in millions):

Line item

Carrying value (CV) of

Investee

Fair value (FV) of

Investee Investor share of Investee CV

Investor share of

Investee FV

Current assets $50 $50 $20 $20

Fixed assets 50 90 20 36

Net assets $100 $140 $40 $56

How should Investor record its investment in Investee on the acquisition date?

Analysis

Investor should record its investment in Investee at its cost of $56 million. The difference

between the Investor’s share of the net assets measured at (1) fair value (i.e., its outside basis)

and the (2) investors share of the investee’s carrying value (i.e., the inside basis) is $16 million

($56 – $40) and is entirely attributable to the fixed assets. The positive basis difference would

be recorded as fixed assets in the investor’s memo accounts and would be depreciated over the

useful life of the fixed assets. The depreciation would be recorded by the Investor as a

reduction of the Investor’s share of the Investee’s earnings and would reduce the Investor’s

equity method investment balance.


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EXAMPLE EM 3-6

Accounting for a negative basis difference on the date of acquisition

Investor purchased a 40% interest in the voting common stock of Investee for $32 million.

Investor determined that it has the ability to exercise significant influence over the operating

and financial policies of Investee. Therefore, Investor accounts for its interest in Investee

under the equity method.

Investor performed extensive due diligence of Investee. During that process, Investor noted

that Investee had recently performed a long-lived asset impairment test for its fixed assets and

determined that the carrying value of its fixed assets were recoverable under a held and used

model. Therefore, no impairment charge was recorded by Investee (even though there had

likely been a decline in the fair value of the fixed assets to below carrying value). As a result,

the cost of the investment was less than the Investor’s proportionate share in the amount at

which the Investee carries the underlying net assets.

At the date of acquisition, Investee’s assets and liabilities are as follows (in millions):

Line item

Carrying value (CV) of

Investee

Fair value (FV) of

Investee

Investor share of

Investee CV Investor share of

Investee FV

Current assets $50 $50 $20 $20

Fixed assets 50 30 20 12

Net assets $100 $80 $40 $32

How should Investor record its investment in Investee on the acquisition date?

Analysis

Investor should record its investment in Investee at its cost of $32 million. The difference

between the Investor’s share of the net assets measured at (1) fair value (i.e., its outside basis)

and (2) the investors share of the investee’s carrying value (i.e., the inside basis) is negative $8

million ($32-$40) and is entirely attributable to the fixed assets. This negative basis difference

would be accreted in the investor's equity method memo accounts reducing depreciation

expense over the life of the fixed assets. This accretion would be recorded by the Investor as an

increase in Investor’s share of the Investee’s earnings and would also increase the Investor’s

equity method investment balance.

3.3.2 Basis differences when investee has a noncontrolling interest

An investee may consolidate a non wholly-owned subsidiary, and therefore present a

noncontrolling interest on its balance sheet. In such cases, the investor should be mindful of

the value held by the noncontrolling interest when determining the fair value of the assets and

liabilities underlying its investment, as illustrated in Example EM 3-7.


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EXAMPLE EM 3-7

Accounting for the investor’s interest in the net assets of an investee’s non

wholly-owned subsidiary

Investor purchased a 40% interest in the voting common stock of Investee and determined

that it should account for its interest under the equity method.

Investee holds an 80% interest in Subco and consolidates Subco in its financial statements.

Investee presents the 20% interest in Subco held by other investors as a noncontrolling

interest.

Subco has fixed assets which Investee includes in its consolidated financial statements. The

carrying amount of the fixed assets for Investee is $100, and it is determined that the fair

value of the fixed assets is also $100.

When determining its proportionate share in the assets and liabilities of Investee, what would

be the Investor’s interest in the fixed assets of Subco?

Analysis

Investee is required to consolidate 100% of the net assets of Subco and present separately the

20% noncontrolling interest, as described in FSP 2.5. Investor, however, should only recognize

its proportionate share of the investee’s interest in those net assets. The Investor’s interest in

the fixed assets of Subco would be $32 (Fair value of the fixed assets [$100] x percentage

owned by Investee [80%] x Investor’s ownership percentage [40%]). Accordingly, Investor

should allocate $32 to the fixed assets of Subco in its memo accounts.

3.3.3 Equity investment acquired as part of a business combination

A reporting entity may acquire a business that has an equity method investment. As part of its

purchase price allocation, the reporting entity should determine the fair value of the equity

method investment, as described in BCG 2.5. The reporting entity should also determine any

basis differences, following the guidance described in EM 3.3.1.

3.3.4 Deferred taxes in investor’s equity method memo accounts

While an investee’s financial statements will already reflect deferred tax assets and liabilities

for temporary differences between the carrying values of the investee’s assets and liabilities

and their associated tax bases, incremental temporary differences may be created when the

investor allocates its investment cost to individual assets and liabilities in memo accounts, as

described in EM 3.3.1.

Accordingly, an investor must track the deferred tax consequences associated with these

incremental basis differences and reflect those tax consequences in its equity method memo

accounts. This is accomplished by tax affecting basis differences using the investee’s tax rate

and including any resulting deferred tax asset or liability in the memo accounts.


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As the investor amortizes its excess basis in the memo accounts, it would unwind the

corresponding deferred tax liability, and recognize the associated impact of the tax effected

amortization in its calculated share of the investee’s earnings.

At acquisition, an investor may also need to consider how its equity method accounting

interplays with any previously established valuation allowances of the investee. See EM 3.3.4.1

for further discussion.

Subsequent to the acquisition, an investor may recognize income for book purposes but not

receive distributions of those earnings. This will create a difference between the carrying

amount of the equity method investment and its tax basis (i.e., outside basis difference), which

is discussed in TX 11.6.

Example EM 3-8 illustrates the establishment of a deferred tax liability related to basis

differences.

EXAMPLE EM 3-8

Establishing a deferred tax liability related to basis differences

Investor obtains a 40% interest in Investee. Investee’s carrying amount of its fixed assets is

$50, whereas the fair value is $90. Accordingly, a difference exists between Investor’s

proportionate share of the fair value of Investee-owned property, plant, and equipment, which

is $36 ($90 x 40%), and the Investee’s carrying amount in those same assets, which is $20

($50 x 40%). This basis difference of $16 ($36-$20) would be reflected in the Investor’s memo

account.

Investee’s tax rate is 25%.

Should Investor recognize a deferred tax liability in connection with allocating its cost basis to

the acquired assets and liabilities?

Analysis

Yes. In the equity method memo accounts, a deferred tax liability should be recognized. That

deferred tax liability reflects the taxable temporary difference created in the memo account of

the Investor (i.e., the amount by which the investor’s carrying amount exceeds its

proportionate interest in the investee’s carrying value of those assets). Accordingly, a deferred

tax liability of $4 would be established, calculated as the $16 basis difference multiplied by the

Investee’s 25% tax rate.

3.3.4.1 Considerations related to investee’s valuation allowance

An investee may have deferred tax assets for which a partial or full valuation allowance has

been recorded. This would occur when the investee has concluded that the deferred tax assets

are not “more-likely-than-not” to be realized.

When an investor records its proportionate interest of the investee, the investor must consider

whether there is any new information resulting from its acquisition of the investee which

results in an impact on investee’s valuation allowance. ASC 740 provides four sources of future


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taxable income to consider when assessing the need for a valuation allowance (see TX 5.3).

One of the sources is future taxable amounts resulting from the reversal of taxable temporary

differences. When an investor recognizes a deferred tax liability in its memo accounts (as

explained in EM 3.3.4), the investor should consider whether that deferred tax liability can

serve as a source of future taxable income to support realization of the investor’s

proportionate share of deferred tax assets acquired.

Example EM 3-9 illustrates a scenario where a deferred tax liability recognized in the

investor’s memo account serves as a source of realization for a deferred tax asset of an

investee. This source of realization relates to the investor’s memo accounts and investor’s

share of the earnings of investee.

EXAMPLE EM 3-9

Determining whether a deferred tax liability recognized in a memo account serves as a source

of realization for a deferred tax asset of an equity method investee

Investee has a deferred tax asset of $400 associated with net operating losses. Investee

recognized a valuation allowance of $400 against the deferred tax asset as it believes that it is

“more-likely-than-not” that the benefit associated with the deferred tax asset will not be

realized. Investee’s balance sheet shows net assets of $750. Investee has a tax rate of 25%.

Investor acquires a 40% equity interest in Investee for $800, and accounts for its investment

using the equity method of accounting. Investor’s proportionate share in the investee’s book

basis is $300 ($750 x 40%), resulting in a basis difference of $500 ($800-$300). Investor

determined that the basis difference is entirely associated with intellectual property which will

be amortized for book purposes over 10 years. Investor’s acquisition of Investee’s equity

interest did not generate any tax basis in the intellectual property. Accordingly, Investor

should record a deferred tax liability of $125 ($500 * 25%) related to the basis difference in its

equity method memo accounts.

Investor determined that its proportionate share of Investee’s deferred tax asset is $160

($400 x 40%).

Should Investor recognize any portion of the underlying deferred tax asset of Investee?

Analysis

Yes. The deferred tax liability recorded by Investor within the equity method memo accounts

should be considered a potential source of taxable income to support realization of its

proportionate share of Investee’s deferred tax assets, regardless of the assessment concluded

and recorded by Investee. Therefore, Investor would recognize $125 of the deferred tax asset

(i.e., no valuation allowance is needed for that portion) in its equity method memo accounts

upon acquisition of Investee. This reflects the portion of the deferred tax asset for which

Investor has a source of taxable income to support realization of its portion of Investee’s

deferred tax assets (through future reversal of the deferred tax liability recognized in its equity

method memo account).


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In some cases, an investor may be willing to pay a premium to obtain an interest in such an

investee if the investor believes that the associated deferred tax assets have value in excess of

the amount recorded (net of the valuation allowance) in the investee’s financial statements.

Simply paying a premium does not in and of itself provide evidence of future taxable income

under ASC 740. In such cases, no portion of the premium would be allocated to the investee’s

deferred tax assets.

Example EM 3-10 illustrates an investor’s accounting for the excess of the cost of the investor’s

share of investee net assets when a premium is attributable to tax benefits of the investee that

carry a valuation allowance.

EXAMPLE EM 3-10

Accounting for the excess of cost over the investor’s share of investee net assets when a

premium is attributable to tax benefits of the investee that carry a valuation allowance

Investee is a public company that has a substantial deferred tax asset related to net operating

loss (NOL) carryforwards. Investee has a full valuation allowance recorded against the

deferred tax asset because of losses in recent years. Investee is currently traded at a premium

compared to its net assets, which has been attributed to a belief by investors that Investee will

eventually be able to employ a strategy to utilize its NOL carryforwards.

Investor acquired a 20% ownership interest in the voting common stock of Investee and

determined that it should account for the investment under the equity method of accounting.

At the date on which Investor acquires its 20% interest in Investee at market price, its cost

exceeds its proportionate share of the carrying amount of the net assets of Investee by $500.

For simplicity, assume there are no unrecognized intangible assets or liabilities and no

other recognized assets or liabilities of Investee to which the premium paid by Investor should

be attributed.

Should any portion of the $500 premium paid by Investor be assigned to the deferred taxes

related to NOL carryforwards, or is the entire premium allocated to goodwill?

Analysis

The premium should be allocated to goodwill. There are no new sources of taxable income as a

result of the initial equity method accounting that could provide for realization of Investee’s

deferred tax assets. Additionally, since there has been no change in control, the Investor’s

investment does not provide the Investee with any new ability to recover the deferred tax

asset. Accordingly, Investor would not assign any carrying value to the deferred tax asset when

assigning the premium paid to acquire the investment. Instead, the $500 premium of cost

over fair value should be considered goodwill in Investor’s equity method memo accounts.

Prospectively, Investor will need to analyze its investment for impairment in accordance with

the provisions of ASC 323-10-35-32. See EM 4.8 for further information.

3.3.5 Accounting for excess assigned to purchased IPR&D (equity method)

A portion of the value paid by an investor to acquire an equity interest in an investee may be

due to the value of in-process research and development (IPR&D) of the investee. An investor


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should measure the underlying IPR&D at fair value at the acquisition date in its memo

accounts.

If the investee is not a business (i.e., an asset acquisition), as defined in ASC 805, the investor

should immediately recognize a charge to expense for acquired IPR&D if the IPR&D does not

have an alternative future use (see ASC 805-50-35-1).

If the investee qualifies as a business, the investor should record an intangible asset to

capitalize the IPR&D in its equity method memo accounts, regardless of whether it has an

alternative future use, as if the investee were a consolidated subsidiary pursuant to the

guidance in ASC 323-10-35-13.

See the guidance described in BCG 1.2 to determine if an acquisition meets the definition of a

business. See BCG 4.3.4.1 for further information on the accounting for purchased IPR&D.

3.3.6 Equity method goodwill

The investor’s cost of an equity method investment may exceed its proportionate share of the

fair value of the investee’s underlying assets and liabilities identified. This excess

consideration paid over the investor’s share of the investee’s net assets, should be assigned by

the investor to “equity method goodwill,” if the investee meets the definition of a business as

described in BCG 1.2. If the investee does not meet the definition of a business, equity method

goodwill should not be recognized. Rather, the excess, if any, should be allocated to the assets

acquired, based on their relative fair values, in a manner similar to the acquisition of assets

described in ASC 805-50-30-3.

An investor should make all reasonable efforts to attribute the cost of the investment to

identifiable assets and liabilities of the investee before determining that the excess paid

reflects goodwill. This includes considering not only the fair value of assets and liabilities

already recognized by the investee, but also assets and liabilities that may not have been

previously recognized by the investee, such as intangibles. If the cost of the investment is

incorrectly attributed to goodwill, ongoing earnings may be misstated as goodwill is generally

not amortized.

The carrying amount of an equity method investment reflects the accumulated cost of the

investment and includes items such as transaction costs (see EM 3.2.1), and subsequent

changes in the value of contingent consideration (see EM 3.2.2), which would not be included

in the carrying amount of business combination accounted for in accordance with ASC 805.

Accordingly, goodwill for an equity method investment, which is calculated as the residual of

the cost paid over the assets and liabilities identified, may be different than if the investment

was a business combination accounted for under ASC 805.

This subsequent accounting for goodwill, including the private company goodwill accounting

alternative, is discussed in EM 4.3.1.

Example EM 3-11 illustrates the process for allocating the cost of an investment to the

underlying net assets, deferred taxes, and equity method goodwill.


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EXAMPLE EM 3-11

Assignment of basis differences with residual excess assigned to equity method goodwill

Investor purchased a 25% interest in the voting common stock of Investee for cash

consideration of $1,000. On the acquisition date, the net assets of Investee, as reflected in its

general ledger and determined in accordance with GAAP, were as follows:

Line Item Balance

Cash $175

Other net current assets 125

Fixed assets 1,200

Net assets $1,500

Investor’s 25% share $375

Investor determined the following:

□ Investee’s property and plants are modern with current technologies and have a fair value

of $2,400.

□ Investee holds valuable patents on its technical processes that have a fair value of $400.

Costs associated with developing the processes were fully expensed by Investee.

□ Investee has a strong earnings growth record, a relevant consideration for income tax

accounting purposes (e.g., realizability of deferred tax assets). Investee’s applicable tax

rate is 25%.

□ Other net current assets represent raw materials, receivables, and payables. The carrying

values of these items approximate their fair value.

How should Investor account for the basis difference between the cost of its investment and its

share of the net assets of the Investee?

Analysis

The following table illustrates how Investor would assign the $625 basis difference that

reflects the difference between its proportionate interest in (a) the carrying value of the

investee’s assets and liabilities and (b) the fair value of those assets and liabilities.


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Line item Carrying

value (CV) Fair value (FV) Excess of

FV over CV

Investor’s interest in

CV

Investor’s basis

difference

Cash $175 $175 $0 $44 $0

Other net current assets 125 125 0 31 0

Fixed assets 1,200 2,400 1,200 300 300

Patents 0 400 400 0 100

Deferred tax liability 0 (400) A (400) 0 (100)

Goodwill 0 1,300 1,300 0 325 C

Total 1,500 4,000 B 2,500 375 625

A – The deferred tax liabilities relate to the difference between the underlying fair values and

the carrying values of the investee’s assets and liabilities. The deferred tax liability of $400 is

calculated as the product of total taxable temporary differences, excluding goodwill ($1,200

basis difference of fixed assets + $400 basis difference of patents), and the Investee’s

applicable tax rate (25%). It is assumed for simplicity that at the date of investment there is no

difference between the investor’s book and tax bases in the investment. If there were such a

difference, the deferred tax effects might have to be considered in allocating the investor’s

excess cost of its investment. See TX 11 for further information.

B – Investor purchased a 25% interest in the voting common stock for $1,000. Therefore, for

illustrative purposes, the fair value of 100% of the Investee is assumed to be $4,000.

C – Equity method goodwill is calculated as the excess of Investor’s purchase price paid to

acquire the investment over the fair value amounts assigned to the identified tangible and

intangible assets and liabilities (fair value of Investor’s share of Investee’s net assets).

Investor would record its 25% interest in the voting common stock of Investee based on the

$1,000 cost of its investment. The underlying acquired assets include the investors

proportionate interest in: (1) the net assets of the investee based on the investee’s carrying

amount ($1,500 x 25% = 375), (2) the net excess of fair value over the investee’s carrying value

of the identified tangible and intangible assets and liabilities as well as goodwill ($625).

3.3.7 Bargain purchase

In limited cases it is possible that the fair value of the investment acquired (i.e., the fair value

of the investor’s share of the investee’s net assets) exceeds the cost of the investment. In such

situations, the investor should not recognize a bargain purchase gain, even though such gains

would be recognized in the context of a business combination in accordance with ASC 805.


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A bargain purchase gain should not be recognized when an investor acquires an equity method

investment because, unlike in a business combination, an investor in an equity method

investment does not control the underlying assets of the investee. Therefore, the investor

would not be able to realize the gain by selling the underlying assets of the investee.

Additionally, the carrying amount of an equity method investment is based on the

accumulated cost of acquiring the investment, not on a fair value basis.

Therefore, if the fair value of the investment acquired exceeds the cost of the investment, the

investor should allocate the difference as a pro-rata reduction (on a fair value basis) to the

amounts that would otherwise have been assigned to the acquired noncurrent assets. This

treatment of the residual excess is consistent with the asset acquisition guidance in

ASC 805-50.

Example EM 3-12 illustrates the allocation of a bargain purchase as a pro rata reduction to the

acquired noncurrent assets.

EXAMPLE EM 3-12

Assignment of a bargain purchase to reduce acquired noncurrent assets

Investor purchased a 25% interest in the voting common stock of Investee for cash

consideration of $1,000. Investee’s tax rate is 25%. On the acquisition date, Investor’s share of

the net assets of Investee on a book and fair value basis are as follows:

Line item Carrying

value Fair

value

Investors share

carrying value

Investor’s share preliminary fair

value

Cash $800 $800 $200 $200 A

Accounts receivable 1,000 1,000 $250 $250 A

Fixed assets 2,000 3,700 $500 925 B

Patent (noncurrent) 0 220 0 55 C

Deferred tax liability 0 (480) 0 (120) D

Accounts payable (800) (800) (200) (200) A

Total $3,000 $4,440 $750 $1,110 E

A – Investor concluded that Investee’s carrying value was representative of fair value.

B – Investor determined that its share of the fair value of Investee’s fixed assets was $925.

C – Investor determined that its share of the fair value of Investee’s patent was $55.


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D – The preliminary deferred tax liability ($120) is calculated as the product of total taxable

temporary differences, excluding goodwill. That includes the sum of the basis difference for

fixed assets ($925-$500 = $425) and the basis difference of the patent ($55) multiplied by the

Investee’s applicable tax rate (25%). It is assumed for simplicity that there is not any

difference at the date of investment between the investor’s book and tax bases in the

investment. If there were such a difference, the deferred tax effects might have to be

considered in allocating the investor’s excess cost of its investment. See TX 11 for further

information.

E – Investor’s proportionate share of the fair value of Investee’s net assets of $1,110 exceeds

the cost of its investment of $1,000, resulting in residual excess of $110.

How should Investor account for the basis difference between the cost of the investment

($1,000) and its share of the Investee’s net assets ($1,110)?

Analysis

Investor should not recognize a bargain purchase gain of $110 for the amount by which the

fair value of its investment exceeds its cost. Rather, Investor should allocate the excess $110 as

a pro-rata reduction of the preliminary fair value amounts assigned to the fixed assets and

patent and related deferred tax effects utilizing an iterative calculation. After performing such

an iterative calculation, which can be accomplished through use of basic software, the final fair

value of Investor’s proportionate share of the Investee’s net assets, including the deferred tax

liability, should equal Investor’s cost of the investment.

Line item Carrying

value Preliminary

fair value Final fair

value Basis

difference

Cash $200 $200 $200 $0

Accounts receivable 250 250 250 0

Fixed assets 500 925 786 286

Patent (noncurrent) 0 55 47 47

Deferred tax liability 0 (120) (83) (83)

Accounts payable (200) (200) (200) 0

Share of net assets $750 $1,110 $1,000 $250

Investor should assign the adjusted basis differences of $286 and $47 to the acquired fixed

assets and patent, respectively, within the equity method memo accounts.

3.3.8 Accumulated other comprehensive income – basis differences

An investee may hold assets or liabilities whose changes in value are reported in accumulated

other comprehensive income (AOCI) pursuant to other GAAP. For example, an investee may


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have investments in available-for-sale securities accounted for pursuant to ASC 320,

Investments–Debt and Equity Securities, derivative financial instruments accounted for

pursuant to ASC 815, Derivatives and Hedging (e.g., derivative financial instrument

designated as a cash flow hedge), and/or pension or post-employment benefits accounted for

pursuant to ASC 715, Compensation—Retirement Benefits.

At the date on which it obtains an investment that is to be accounted for under the equity

method of accounting, an investor must identify and measure all of the investee’s identifiable

assets and liabilities at their acquisition date fair values. For those assets and liabilities whose

changes in value are reported in AOCI, the investor will not recognize its proportionate share

of the amounts previously reported in the investee’s AOCI balance. This is because the

investor would record the associated assets and liabilities at fair value and, therefore, there are

no unrealized amounts to report in AOCI from the investor’s perspective.

Accordingly, the amounts reported in the investee’s AOCI balance create additional basis

differences that must be tracked by the investor within the equity method memo accounts in

order to ensure that the investor does not recognize such amounts when they are reclassified

to earnings in the investee’s financial statements.

Example EM 3-13 illustrates an investor’s accounting for the investee’s AOCI at date of

acquisition and upon sale.

EXAMPLE EM 3-13

Investor’s accounting for investee’s AOCI at date of acquisition and upon sale

Investor acquired a 20% interest in the voting common stock of Investee that will be

accounted for under the equity method of accounting. Investee holds an available-for-sale

debt security that it purchased for $100. The fair value of the available-for-sale debt security at

the investment date is $150; therefore, investee reports $50 in unrealized gains in AOCI. One

year later, Investee sells the available-for-sale security for $150.

How should Investor account for its proportionate share of Investee’s available-for-sale debt

security at the investment date and upon Investee’s sale of the available-for-sale security?

Analysis

At the acquisition date, Investor would recognize in its memo accounts its proportionate share

of the fair value of the available-for-sale debt security of $30 ($150 * 20%) and AOCI of $0,

creating a basis difference of $10 in the investor’s AOCI memo accounts.

Upon sale for $150, Investee would recognize a realized gain of $50; however, Investor would

not record its proportionate share of Investee’s realized gain because its basis in the Investee’s

available-for-sale debt security would already reflect the security’s appreciation. Therefore,

Investor would reduce its equity in earnings of Investee by $10 ($50 * 20%), reflecting the

reversal of the AOCI basis difference.


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3.3.9 Investee financial statements are not US GAAP

When an investee’s financial statements are prepared on a basis other than US GAAP, an

investor that follows US GAAP should convert the investee’s financial statements to US GAAP

to eliminate variances, prior to determining the difference between the cost of its investment

and its share of the underlying equity in the investee’s net assets. Variances from US GAAP

must be accounted for on a continuing basis, similar to the required accounting for basis

differences discussed in EM 3.3.1. See EM 4.3.4 for further discussion of adjustments for the

application of different accounting principles by the investee.

3.3.10 Investee reporting on a lag

If an investor determines that the financial statements of an investee will not be ready at the

time the investor files its financial statements, the investor can elect to adopt an accounting

policy to use financial statements of the investee as of an earlier reporting period. A lag in

reporting should be consistent from period to period as noted in ASC 323-10-35-6.

While ASC 323 does not specifically state the maximum permissible lag for equity method

investees, ASC 810-10-45-12, which addresses consolidated subsidiaries, states it should not

be more than “about three months.” We believe the same guidance can be applied by analogy

to equity method investees.

When lag reporting will be applied, the investor should determine the equity method basis

differences at the date of acquisition using (a) the cost of the investment and (b) its

proportionate interest in the carrying amount of the investee’s assets and liabilities as of the

acquisition date.

See EM 4.4 for subsequent accounting for investments with lag reporting.

PwC 1

Chapter 4:

Subsequent accounting for equity method investments


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4.1 Subsequent accounting for equity method investments

The subsequent accounting for an equity method investment generally follows the consolidation

model. An investor increases the carrying amount of the investment to reflect its contributions and its

share of the investee’s earnings, and reduces it to reflect its share of investee’s losses, investee

distributions, and other-than-temporary impairments.

4.1.1 Share of earnings of the investee

When the initial equity method investment is recorded at cost, the investor recognizes its

proportionate share of the reported earnings or losses of the investee through net income and as an

adjustment to the investment balance. This proportionate share is subject to adjustments, such as for

the elimination of intra-entity (intercompany) gains or losses or amortization of basis differences.

The investor’s share of investee earnings or losses is generally based on shares of common stock or in-

substance common stock held by the investor. However, there may also be other investments that

participate in earnings. For example, an investor may need to record earnings on an investment in

investee’s preferred stock. Refer to EM 4.5.2 for further discussion.

Determining the investor’s share of the earnings or losses of the investee may be straightforward when

all income and distributions (including distributions in liquidation) are determined based on interests

held or a fixed percentage allocated to each equity holder. The allocation becomes more complex when

the investee has multiple classes of equity outstanding or the allocation of earnings or cash

distributions to investors is not commensurate with ownership interests.

If an investee has multiple classes of common stock outstanding, analysis is required to determine if a

single class is subordinate or if all classes possess substantially identical subordination characteristics

when determining the investor’s share of the investee’s earnings or losses.

4.1.2 Preferred stock impact on share of earnings of the investee

An investor would not adjust its share of the investee’s earnings or losses for any non-cumulative

preferred dividends unless those dividends were declared, but would adjust to deduct the investee’s

cumulative preferred dividends, regardless of whether those dividends have been declared. However,

some preferred dividends are only cumulative when earned, so preferred shareholders would not have

a future claim for dividends if sufficient income has not been generated. In that case, the investee

income (loss) is only adjusted to the extent preferred dividends are earned.

Accretion of redeemable preferred stock classified in temporary equity is required when the stock is

redeemable at a fixed or determinable date, or at any time at the holder’s option. The equity method

investor should adjust its share of earnings (or losses) of the investee for this accretion.

4.1.3 Non-pro rata profit allocations

Investment agreements may include allocations among investors for the investee’s earnings, taxable

profit and loss, distributions of cash from operations, and/or distributions of cash proceeds on

liquidation that differ from the investor’s ownership interest. These agreements can impact the

investor’s recognition of its share of the investee earnings for accounting purposes. All relevant


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agreements among the investors should be evaluated to determine the rights of each investor. To be

considered substantive, the profit allocation should be consistent over time (i.e., not able to be

unwound based on subsequent events).

ASC 970, Real Estate, contains guidance on the allocation of investee earnings for investments in real

estate ventures. In practice, this guidance is also considered when determining an investor’s share of

an investee’s earnings for investments in non-real estate ventures.


Such agreements may also provide for changes in the allocations at specified times or on the

occurrence of specified events. Accounting by the investors for their equity in the venture’s earnings

under such agreements requires careful consideration of substance over form and consideration of

underlying values as discussed in paragraph 970-323-35-10. To determine the investor’s share of

venture net income or loss, such agreements or arrangements shall be analyzed to determine how an

increase or decrease in net assets of the venture (determined in conformity with GAAP) will affect cash

payments to the investor over the life of the venture and on its liquidation. Specified profit and loss

allocation ratios shall not be used to determine an investor’s equity in venture earnings if the

allocation of cash distributions and liquidating distributions are determined on some other basis.

ASC 970-323-35-17 concludes that the contractual non-pro rata profit allocation should be followed

for accounting purposes only when the allocation of cash distributions over the life of the investee and

upon its liquidation are determined on the same basis.

One example of a specified profit allocation is when one investor that may be able to monetize tax

benefits generated by the investee entity is allocated all tax credit benefits, while the other investors

receive all other operating income and losses. Alternatively, an investor may have preference over

other investors for the first set amount of income earned by the investee entity, after which there is a

pro-rata allocation among all investors.

One way to apply the equity method in these circumstances is referred to as the hypothetical

liquidation at book value method, which is discussed in ASC 323-10-35-27 to ASC 323-10-35-28 and

ASC 323-10-55-48 to ASC 323-10-55-57 and the following section.

4.1.4 Hypothetical liquidation at book value method

There is no prescriptive guidance for determining an investor’s share of investee earnings for

investments in complex structures. The hypothetical liquidation at book value (HLBV) method,

referred to as a balance sheet approach, calculates the share of investee earning or losses based on the

change in the investor’s claim on the net assets of the investee (i.e., how an entity would allocate and

distribute its cash if it were liquidated as of the balance sheet date based on its articles of

incorporation, bylaws, or other governing documents).

Under the HLBV method, an investor would calculate its share of current period investee earnings as

illustrated in Figure EM 4-1.

http://www.pwccomperio.com/contents/english/external/us/gaap/970/970-323-35.htm#p35-17

https://inform.pwc.com/inform2/show?action=informContent&id=0110031362676225#FASB_COD_323_10


4-4

Figure EM 4-1 HLBV method to determine current period investee earnings

plus minus minus

The AICPA detailed the HLBV method in a proposed Statement of Position, Accounting for Investors’

Interests in Unconsolidated Real Estate Investments. While it was never finalized, the proposed

guidance is used by investors to determine equity method earnings when a non-pro rata profit

allocation is in place. However, investors should assess if the use of the HLBV method is appropriate

and consistent with the economic substance of the profit allocation. In practice, contractual

distribution of cash upon liquidation (i.e., liquidation waterfalls) are often complex and reporting

entities should carefully evaluate all relevant agreements.

ASC 323-10-55-49 begins an example that illustrates the approach to determining the amount of

equity method earnings based on the change in the investor’s claim on the investee’s book value. While

not specifically referred to as HLBV, the example illustrates similar concepts.


a. Investee was formed on January 1, 20X0.

b. Five investors each made investments in and loans to Investee on that date and there have not

been any changes in those investment levels (that is, no new money, reacquisition of interests by

Investee, principal payments by Investee, or dividends) during the period from January 1, 20X0

through December 31, 20X3.

c. Investor A owns 40 percent of the outstanding common stock of Investee; the common stock

investment has been reduced to zero at the beginning of 20X1 because of previous losses.

d. Investor A also has invested $100 in preferred stock of Investee (50 percent of the outstanding

preferred stock of Investee) and has extended $100 in loans to Investee (which represents 60

percent of all loans extended to Investee).

e. Investor A is not obligated to provide any additional funding to Investee. As of the beginning of

20X1, the adjusted basis of Investor’s total combined investment in Investee is $200, as follows:

Common stock $—

Preferred stock $100

Loan $100

f. Investee operating income (loss) from 20X1 through 20X3 is as follows:

20X1 ($160)

20X2 ($200)

Claim on net assets at the end of the period

assuming investee entity was liquidated or sold at book value

Distributions received by the investor

Contribution made to or

new investments

in the investee

The investor’s prior period claim on net assets assuming the

investee was liquidated or sold at book value

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20X3 $500

g. Investee’s balance sheet is as follows:

1/1/X1 12/31/X1 12/31/X2 12/31/X3

Assets $ 367 $ 207 $ 7 $ 507

Loan 167 167 167 167

Preferred stock 200 200 200 200

Common stock 300 300 300 300

Accumulated deficit (300) (460) (660) (160)

$ 367 $ 207 $ 7 $ 507

ASC 323-10-55-54

Under this approach, Investor A would recognize equity method losses based on the change in the

investor’s claim on the investee’s book value.

ASC 323-10-55-55

With respect to 20X1, if Investee hypothetically liquidated its assets and liabilities at book value at

December 31, 20X1, it would have $207 available to distribute. Investor A would receive $120

(Investor A’s 60% share of a priority claim from the loan [$100] and a priority distribution of its

preferred stock investment of $20 [which is 50% of the $40 remaining to distribute after the creditors

are paid]). Investor A’s claim on Investee’s book value at January 1, 20X1, was $200 (60% × $167 =

$100 and 50% × $200 = $100). Therefore, during 20X1, Investor A’s claim on Investee’s book value

decreased by $80 and that is the amount Investor A would recognize in 20X1 as its share of Investee’s

losses. Investor A would record the following journal entry.

Equity method loss $80

Preferred stock investment $80

ASC 323-10-55-56


December 31, 20X2, it would have $7 available to distribute. Investor A would receive $4 (Investor A’s

60% share of a priority claim from the loan). Investor A’s claim on Investee’s book value at December

31, 20X1, was $120 (see the preceding paragraph). Therefore, during 20X2, Investor A’s claim on

Investee’s book value decreased by $116 and that is the amount Investor A would recognize in 20X2 as

its share of Investee’s losses. Investor A would record the following journal entry.

Equity method loss $116

Preferred stock investment $20

Loan $96

ASC 323-10-55-57


December 31, 20X3, it would have $507 available to distribute. Investor A would receive $256

(Investor A’s 60% share of a priority claim from the loan [$100], Investor A’s 50% share of a priority

distribution from its preferred stock investment [$100], and 40% of the remaining cash available to

distribute [$140 × 40% = $56]). Investor A’s claim on Investee’s book value at December 31, 20X2,

was $4 (see above). Therefore, during 20X3, Investor A’s claim on Investee’s book value increased by


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$252 and that is the amount Investor A would recognize in 20X3 as its share of Investee’s earnings.

Investor A would record the following journal entry.

Loan $ 96

Preferred stock 100

Investment in investee 56

Equity method income $252

4.2 Elimination of intercompany transactions

An investor applying the equity method may need to make adjustments to eliminate the effects of

certain intercompany transactions. While ASC 323 refers to the consolidation guidance under ASC 810

for guidance on eliminations, the extent of the eliminations under the equity method are more limited

than those required when consolidating a subsidiary.

4.2.1 Intercompany profits and losses

An investor should eliminate its intercompany profits or losses related to transactions with an investee

until profits or losses are realized through transactions with third parties. For example, assume an

investor holds a 25% interest in an investee entity and sells inventory at arm’s length to that investee.

If the inventory remains on the books of the investee at the reporting date, then the investor would

generally eliminate 25% of the intercompany profit. Once the inventory is sold by the investee to a

third party, any previously eliminated intercompany profit is recognized. However, intercompany

profits or losses should not be eliminated for arm’s-length transactions that do not result in an asset

that remains on the books of either party. For example, an investee may provide outsourcing services

to the investor for a fee. Intercompany profits or losses for this transaction would not be eliminated.

As discussed in ASC 323-10-35-8, there is a difference in intercompany elimination principles for

equity method investments compared to consolidation. One example is when an investor leases an

item to an investee under an operating lease arrangement. The investor would normally earn rental

income while the investee recognizes rental expense in the same period. No intercompany elimination

would be needed on the basis that the earnings process is complete (i.e., no asset such as inventory

remains on the books of the investor/investee). In contrast, if the investor consolidated the investee,

all rental income earned by the investor and all rental expense incurred by the investee would be

eliminated in the consolidated financial statements.

ASC 323-10-35-7

Intra-entity profits and losses shall be eliminated until realized by the investor or investee as if the

investee were consolidated. Specifically, intra-entity profits or losses on assets still remaining with an

investor or investee shall be eliminated, giving effect to any income taxes on the intra-entity

transactions, except for any of the following:

a. A transaction with an investee (including a joint venture investee) that is accounted for as a

deconsolidation of a subsidiary or a derecognition of a group of assets in accordance with

paragraphs 810-10-40-3A through 40-5.

b. A transaction with an investee (including a joint venture investee) that is accounted for as a

change in ownership transaction in accordance with paragraphs 810-10-45-21A through 45-24


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c. A transaction with an investee (including a joint venture investee) that is accounted for as the

derecognition of an asset in accordance with Subtopic 610-20 on gains and losses from the

derecognition of nonfinancial assets.

ASC 323-10-35-8

Because the equity method is a one-line consolidation, the details reported in the investor’s financial

statements under the equity method will not be the same as would be reported in consolidated

financial statements under Subtopic 810-10. All intra-entity transactions are eliminated in

consolidation under that Subtopic, but under the equity method, intra-entity profits or losses are

normally eliminated only on assets still remaining on the books of an investor or an investee.

ASC 323-10-35-9

Paragraph 810-10-45-18 provides for complete elimination of intra-entity income or losses in

consolidation and states that the elimination of intra-entity income or loss may be allocated between

the parent and the noncontrolling interests. Whether all or a proportionate part of the intra-entity

income or loss shall be eliminated under the equity method depends largely on the relationship

between the investor and investee.

ASC 323-10-35-10

If an investor controls an investee through majority voting interest and enters into a transaction with

an investee that is not at arm’s length, none of the intra-entity profit or loss from the transaction shall

be recognized in income by the investor until it has been realized through transactions with third

parties. The same treatment applies also for an investee established with the cooperation of an

investor (including an investee established for the financing and operation or leasing of property sold

to the investee by the investor) if control is exercised through guarantees of indebtedness, extension of

credit and other special arrangements by the investor for the benefit of the investee, or because of

ownership by the investor of warrants, convertible securities, and so forth issued by the investee.

ASC 323-10-35-11

In other circumstances, it would be appropriate for the investor to eliminate intra-entity profit in

relation to the investor’s common stock interest in the investee. In these circumstances, the percentage

of intra-entity profit to be eliminated would be the same regardless of whether the transaction is

downstream (that is, a sale by the investor to the investee) or upstream (that is, a sale by the investee

to the investor).

If an intercompany transaction is not considered to be at arm’s length, all (as opposed to a portion) of

the intercompany profit or loss is eliminated until it has been realized through sale to third parties.

Investors should consider all facts and circumstances to determine if the transaction is at arm’s length,

including the transaction’s economic substance, whether the sales price is collectible, whether the sales

price represents fair value, and if the terms of the transaction are similar to those in third-party

transactions.

After consideration of the nature of the transaction and the relationship between the investor and

investee, the appropriate portion (all or some) of intercompany profits or losses should be eliminated,

even if the investor’s share of the unrealized profit to be eliminated exceeds the carrying amount of the

equity method investment and would reduce the investor’s equity method investment balance below

zero. Profits that were recognized before the investor acquired its interest in the investee, such as when


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inventories or other assets were sold by one company to another prior to the equity method

investment, should generally not be eliminated.

The examples in ASC 323-10-55-27 through ASC 323-10-55-29 illustrate the elimination of

intercompany profit in both upstream (investee sells inventory to investor) and downstream (investor

sells inventory to investee) transactions within the scope of ASC 606.

The general approach to eliminate intercompany profits by debiting equity method earnings and

crediting the equity method investment is an acceptable presentation method for both sales by an

investor to an investee and sales by an investee to an investor. A net-of-tax basis of elimination is also

considered acceptable because the presentation of equity in income of the investee under the equity

method is normally on a single line, net-of-tax basis in the income statement of the investor.

Example EM 4-1 and Example EM 4-2 illustrate the general presentation approach and several

alternatives for income statement and balance sheet presentations in the context of a sale of inventory

at arm’s length between an investor and investee.

EXAMPLE EM 4-1

Elimination of intercompany gains or losses - downstream

Investor has a 30% interest in Investee, and accounts for its investment under the equity method of

accounting. Investor sells five units of inventory to Investee for $100 each for total intercompany sales

of $500. As the Investor’s related cost for this inventory is $50 per unit ($250 in total), the

intercompany profit related to this transaction is $250. As of the end of the Investee’s reporting

period, two units remain in inventory. This results in an elimination of $100 intercompany profit ($50

per unit remaining in inventory). Investor and Investee are both subject to a 20% income tax rate.

What are the ways in which the elimination entries can be determined?

Analysis

General approach: Debit equity method earnings and credit investment account on a net-of-tax basis

to eliminate the profit for the two units left in inventory ($50 profit x 2 units less 20% income tax).

Dr. Equity method earnings $80

Cr. Equity method investment $80

Alternative 1: Debit cost of sales and credit the investment account for the pre-tax amount of the

intercompany income elimination. Credit a deferred income tax provision in the income statement and

debit a deferred income tax asset on the balance sheet.

Dr. Cost of sales $100

Dr. Deferred income tax benefit $20

Cr. Equity method investment $100 Cr. Deferred income tax provision $20

Alternative 2: Debit cost of sales and credit deferred income for the pre-tax amount. Credit a deferred income tax provision in the income statement and debit a deferred income tax asset on the balance sheet.


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Dr. Cost of sales $100 Dr. Deferred income tax benefit $20 Cr. Deferred income $100 Cr. Deferred income tax provision $20

Alternative 3: Debit equity method earnings for the net-of-tax amount and a deferred income tax benefit for the amount of the tax benefit. Credit a deferred income account on the balance sheet.

Dr. Equity method earnings $80 Dr. Deferred income tax benefit $20 Cr. Deferred income $100

EXAMPLE EM 4-2

Elimination of intercompany gains or losses – upstream

Investor has a 30% interest in Investee, and accounts for its investment under the equity method of

accounting. Investee sells five units of inventory to Investor for $100 each for total intercompany sales

of $500. As the Investee’s related cost for this inventory is $50 per unit ($250 in total), the

intercompany profit related to this transaction is $250. As of the end of the Investor’s reporting

period, two units remain in inventory. This results in an elimination of $100 intercompany profit ($50

per unit remaining in inventory). Investor and Investee are both subject to a 20% income tax rate.

What are the ways in which the elimination entries can be determined?

Analysis

General approach: Debit equity method earnings and credit investment account on a net-of-tax basis to eliminate the profit for the two units left in inventory ($50 profit x 2 units less 20% income tax).

Dr. Equity method earnings $80 Cr. Equity method investment $80

Alternative 1: Debit equity method earnings for the net-of-tax amount, credit inventory for the gross amount of the elimination, and debit the investment account for the amount of the tax benefit.

Dr. Equity method earnings $80 Dr. Equity method investment $20 Cr. Inventory $100

When inventory has been acquired from a “cost company” (a joint venture formed to serve as a source of supply in which the venturers agree to take production of the investee proportionate to their respective interests; this is substantially a cost-sharing arrangement), the purpose of the intercompany income elimination is to reduce the investor’s inventory cost to the investee’s cost. In the “cost company” situation, Alternative 1 is an acceptable method to record the intercompany profit elimination.

Alternative 2: Debit equity method earnings and credit inventory for the net-of-tax amount

Dr. Equity method earnings $80 Cr. Inventory $80


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4.3 Other adjustments to the share of earnings of the investee

In addition to adjusting for intercompany profits or losses, an investor may need to make other

adjustments to its share of earnings or losses of the investee, including for:

□ subsequent accounting for basis differences (see EM 4.3.1),

□ changes in the investee capital accounts, specifically other comprehensive income (see EM 4.3.2),

□ investee prior period adjustments (see EM 4.3.3),

□ differences in accounting principles (see EM 4.3.4),

□ investor shares held by investee (see EM 4.3.5),

□ the receipt of dividends, which are applied as a reduction of the carrying amount of the

investment, and

□ stock compensation considerations (see EM 4.3.6 and EM 4.3.7).

As highlighted in ASC 323-10-45-1, an investor’s share of earnings or losses from its investment is

shown as a single amount within the investor’s income statement, including the impact of any basis

differences or other adjustments. Included in these adjustments, an investor would report its share of

the investee’s discontinued operations as part of the single amount in the income statement

representing the investor’s share of the investee’s earnings or losses (see EM 4.3.3 for further

discussion).

4.3.1 Subsequent accounting for basis differences

As discussed in EM 3.3, the purchase price paid by an investor for an ownership interest in the voting

common stock of an investee is presumed to reflect fair value (i.e., the price that would be received to

sell an asset in an orderly transaction between market participants). The underlying assets and

liabilities of the investee are recorded at historical cost; therefore, there is usually a basis difference

between the cost of an investment and the investor’s share of the net assets of the investee as reflected

by the investee (historical carrying value).

The basis differences attributed to tangible and separately identifiable intangible assets should be

amortized or depreciated as an adjustment to the investor’s share of earnings or losses of the investee.

Excess cost of the equity method investment over the proportional fair value of the assets acquired and

liabilities assumed of the investee is recognized as equity method goodwill. Differences that are

attributed to equity method goodwill generally would not be amortized. However, a company that

adopts the private company goodwill accounting alternative (“goodwill alternative”) approved by the

Private Company Council and endorsed by the FASB should account for equity method goodwill in the

same manner in which it accounts for goodwill recognized in connection with a business combination.

A private company that recognizes equity method goodwill in connection with an equity method

investment in an investee and adopts the goodwill alternative should amortize such goodwill on a

straight-line basis over 10 years, or less than 10 years if the entity demonstrates that another useful life


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4.3.2

is more appropriate, in accordance with ASC 323-10-35-13. See BCG 9 for further information

regarding the goodwill alternative.

For situations when the investee entity is private and has adopted the goodwill alternative, a public

company investor must eliminate the related effects when calculating its proportionate share of the

equity in earnings of the investee, as the goodwill alternative is not available to public companies. See

further discussion at EM 4.3.4.

If an investee disposes of an asset in which the investor has a related basis difference, the investor

should write off the basis difference and adjust the equity in earnings to correctly reflect the investor’s

proportionate share of the investee’s reported gain or loss.

If an investee records an impairment charge on its long-lived assets under ASC 360, the investor

should review its outside basis in such assets to determine whether any adjustments to its

proportionate share of the investee’s recorded impairment loss are necessary. For example, assume an

investee recognizes a $100 impairment charge on its long-lived assets under ASC 360. If an investor

owns a 40% interest in the voting common stock of the investee and has a $20 basis difference

attributed to the long-lived assets at the impairment date (i.e., the investor’s carrying value in the

investee’s long-lived assets is higher than the investee’s carrying value), a $60 impairment charge

would be included in the investor’s equity in earnings (i.e., its proportionate share of the investee’s

reported impairment charge of $40, adjusted to reflect the write-off of the investor’s $20 basis

difference attributed to the long-lived assets). See EM 4.8.4 for further information on the impact of

impairments recognized by the investee on the investor’s financial statements.

Investee other comprehensive income considerations

As described in ASC 323-10-35-18, if an investee records an increase or decrease in OCI, the investor

should record a corresponding proportionate increase or decrease in its equity method investment,

along with an adjustment to its OCI account. For example, if the investee records an increase in the

fair value of its available-for-sale debt securities within OCI, the investor would record a proportionate

increase in its own OCI balance with an offsetting entry to its equity method investment balance.

While an investor is able to present OCI from equity method investees with its own OCI, it is also

permitted to present components of OCI attributed to an equity method investee separately.

ASC 323-10-35-18

An investor shall record its proportionate share of the investee’s equity adjustments for other

comprehensive income (unrealized gains and losses on available-for-sale securities; foreign currency

items; and gains and losses, prior service costs or credits, and transition assets or obligations

associated with pension and other postretirement benefits to the extent not yet recognized as

components of net periodic benefit cost) as increases or decreases to the investment account with

corresponding adjustments in equity. See paragraph 323-10-35-37 for related guidance to be applied

upon discontinuation of the equity method.

An investor should generally not record investee losses in excess of its investment and any additional

advances whether through net income or OCI, unless the investor has guaranteed the investee’s

obligations or has committed to provide further financial support to the investee. See EM 4.5.

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Accounting for cumulative OCI upon the sale of an interest in investee

An investor that sells a portion of its interest in the investee may recognize a gain or loss on the sale of

those shares. In determining this gain or loss, the basis of the investment would include the investor’s

cumulative OCI relating to the portion of the investment to be sold. The investor would record a

corresponding reclassification adjustment for the credit or debit balance in OCI (i.e., the investor

would reclassify the amounts in OCI to earnings under ASC 220, Comprehensive Income). See EM 5

for further information on sales of investee shares.

Accounting for cumulative translation adjustment relating to an equity method

investment

An equity method investment in a foreign operation may be a standalone foreign entity or it may be

part of a larger foreign entity. If the investor sells its entire ownership interest in an equity method

investment that is part of a larger foreign entity (i.e., the disposition of the equity method investment

did not involve the entire foreign entity), it should not recognize the cumulative translation

adjustment account balance in net income unless the sale is a substantially complete liquidation of

that foreign entity. A partial sale of an equity method investment that is a standalone foreign entity for

which the retained interest will also be accounted for using the equity method requires a pro rata

portion of the cumulative translation adjustment to be recognized in measuring the gain or loss on sale

as prescribed by ASC 830-30-40-2. See FX 8 for more information.

4.3.3 Investee prior period adjustments

Issues can arise when an error or other adjustment reported by the investee relates to a period prior to

when the investor made its investment. The portion of the investor’s share of the investee prior period

adjustment that pre-dates the investment would be treated as an adjustment to the investor’s basis

difference, which would need to be assigned based on the investee’s revised balance sheet amounts as

of the investment date. Depending upon the underlying reasons for the adjustment to the investee’s

financial statements, the investor may need to consider whether its investment is impaired.

If the investee reports a discontinued operation, the investor should consider whether this represents a

strategic shift that has (or will have) a major effect on its own operations and financial results and,

therefore, also requires discontinued operation presentation by the investor. It is rare that the criteria

for discontinued operations would be met at the investor level and therefore an investor would

generally not report discontinued operations in its income statement for its share of the discontinued

operations of an equity method investee. See FSP 27 for further information on the presentation of

discontinued operations. If the investor does not report discontinued operations, it would report its

share of the investee’s discontinued operations as part of the single amount in the income statement

representing the investor’s share of the investee’s earnings or losses.

4.3.4 Differences in accounting principles

An investor and investee may apply different accounting principles in the preparation of their financial

statements.

Investee applies US GAAP

ASC 323-10-20 defines earnings or losses of an investee as income or loss determined in accordance

with US GAAP. The investee is ultimately responsible for the selection of its accounting policies. The


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investee may apply different accounting policies than the investor provided they are acceptable

alternatives under US GAAP. For example, an investee could apply the FIFO method of inventory

costing while the investor applies the LIFO method. As the investee’s method is permissible under US

GAAP, the investor does not need to adjust the investee’s financial statements before recording its

proportionate share of the investee’s earnings.

However, care must be taken in the elimination of intra-entity profits and losses to avoid the

recognition of profit or loss that results solely from differences in accounting policies. For example, an

investor and investee may be counterparties in a long-term natural gas supply contract in which the

investor accounts for the contract as a derivative instrument pursuant to ASC 815, Derivatives and

Hedging (i.e., on a mark-to-market basis, with changes in fair value being reported in earnings) and

the investee elects the normal-purchase, normal-sale scope exception, which results in the investee

accounting for the contract on an accrual basis. The investor may have to eliminate unrealized intra-

entity profits and losses recognized on such a contract. See EM 4.2 for discussion on the elimination of

intercompany profits on transactions between an investor and an investee.

Investee does not apply US GAAP

An investor reporting under US GAAP is required to record its share of earnings or losses and other

changes in net assets of the investee using investee financial statements that are prepared under US

GAAP. The investor should arrange for the investee to prepare financial statements in accordance with

US GAAP or obtain the information necessary to adjust the investee’s financial statements to a US

GAAP basis when the investee’s financial statements have been prepared in accordance with other

acceptable alternatives (e.g., IFRS, other GAAP, or accounting principles prescribed by a regulatory

agency). In cases when an investee’s policies under other GAAP (e.g., IFRS) are not acceptable

alternatives under US GAAP, the investor should conform the investee’s financial information using

policies consistent with its own policies.

Investee applies industry-specific accounting principles

If an investee uses industry-specific accounting principles when preparing its own financial

statements, the investor is required to retain the industry-specific accounting principles in its

application of the equity method as described in ASC 323-10-25-7.

ASC 323-10-25-7

For the purposes of applying the equity method of accounting to an investee subject to guidance in an

industry-specific Topic, an entity shall retain the industry-specific guidance applied by that investee.

This requirement is consistent with the consolidation guidance that similarly requires industry-

specific accounting applied by a subsidiary be retained in its parent’s financial statements.

Investee applies private company accounting alternatives

A public company investor may have an equity method investment in a private company investee that

has elected an accounting alternative (“PCC alternative”) approved by the PCC and endorsed by the

FASB, such as the goodwill accounting alternative discussed in EM 4.3.1. A public company investor

should eliminate the effects of its private company investee’s application of such PCC alternatives as

PCC alternatives are not available to public companies.


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Accounting standards separately adopted by investee

It is common for new accounting standards to allow either early adoption or a delayed mandatory

adoption date for private companies. If the investee adopts an accounting standard before the investor,

the investor is not required to eliminate the effects of the adoption by the investee in its (the

investor’s) financial statements. Similarly, if an investor adopts a new accounting standard before the

investee entity, the investee is not required to also adopt the new accounting standard solely for

purposes of the investor’s equity method accounting. However, care must be taken in the elimination

of intercompany transactions to avoid the recognition of profit or loss that results from a difference in

the investor or investee adopting a new accounting standard before the other entity.

4.3.5 Reciprocal interests

A reciprocal relationship exists when the investor and investee each hold an equity method investment

through interests in the other’s stock. Two methods are commonly applied in practice for an investor

to account for shares held by the investee (the reciprocal shareholding):

□ The treasury stock method

□ The simultaneous equation method

While the treasury stock method is more common in practice, the simultaneous equation method is

also an acceptable alternative, though significantly more complex in application. The investor should

apply its selected method consistently for all reciprocal interests.

Treasury stock method

The treasury stock method considers the investor’s stock held by the investee to be investor treasury

stock. Accordingly, the investor’s share of the investee’s net income is recorded excluding the

investee’s equity method earnings from the investee’s investment in the investor. The investor should

not include shares held by the investee as treasury stock on the investor’s balance sheet.

Simultaneous equation method

The simultaneous equation method is based on a concept for reciprocal interests between a parent

entity and its consolidated subsidiary that are viewed as a single economic unit. The combined

earnings of the equity method investor “parent” and the equity method investee “subsidiary” needs to

reflect the amount that accrues to the “noncontrolling” interests in the equity method investee (i.e., the

other investors in the investee entity), given those investors indirectly own a portion of the investor’s

equity. That is, the amount that accrues to the investee’s other investors (other than the equity method

investor) in the combined economic unit is comprised of the following amounts:

□ The other investors’ interest in the equity method investee’s earnings from its own separate

operations. This excludes any earnings the investee has from its investment in the equity method

investor

□ The other investors’ interest in:

o the investor’s earnings from its separate operations, and


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o the investor’s share of the equity investee’s earnings from the equity investee’s

separate operations (excluding earnings the investee may have from its investment in

the investor entity).

4.3.6 Stock compensation awarded by investee to its employees

Stock-based compensation awarded by an investee to its own employees results in recognition of

compensation cost in net income in the investee’s financial statements over the related vesting period.

The investor would therefore recognize its proportionate share of the compensation expense as part of

its equity method earnings.

When the stock-based compensation is equity classified, the investee records expense with an

offsetting entry to additional paid-in-capital, the net effect of which does not change the investee’s

reported equity. The investor would record its proportionate share of the investee’s stock-based

compensation expense, but there’s a question as to how the investor should account for its share of the

investee’s “credit” entry to additional paid-in-capital.

Generally, an investor accounts for change in interest transactions only when common shares have

been issued by the investee. Therefore, during the vesting period, the investor would generally track its

share of the investee’s credit to additional paid-in-capital in its equity method memo accounts as a

reconciling item. Alternatively, the investor could record the adjustment in its own equity with a

corresponding increase in the investment account similar to how an investee’s changes in OCI are

treated by an investor (see EM 4.3.2 for further information).

However, we do not believe the investor should record its share of the investee’s increase in additional

paid-in-capital as part of its share of earnings of the investee as it would effectively result in the

investor not recording its share of the investee’s compensation expense.

The exercise of an option or vesting of restricted shares decreases the investor’s percentage ownership

in the investee. Therefore, the investor should account for a change in interest as an indirect sale of a

portion of its interest in the investee. Regardless of how the investor accounts for the investee’s

increase in additional paid-in-capital, the investor should adjust its investment for a change in its

share of the investee’s net assets upon exercise of the option or for the vesting of restricted shares. See

EM 5 for further information on accounting for change in interest transactions.

4.3.7 Stock compensation awarded by investor to investee employees

Stock-based compensation that is awarded by an investor to employees of its equity method investee

can have an impact on both the reported investment and the investor’s share of the earnings or loss of


An investor may sponsor a stock-based compensation plan for its investee’s employees. If the other

investors do not provide proportionate funding or the investor does not receive any consideration,

such as an increase in its relative ownership percentage of the investee for the awards, the investor

should expense the entire cost associated with the award when the investee recognizes the related

expense in its books, not just its proportionate share based on ownership interest in the investee. This

assumes that the awards were not agreed to and accounted for as part of the investor’s acquisition of

an interest in the investee.


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The investee will recognize the costs of the stock-based compensation incurred by the investor on its

behalf with a related capital contribution.

Investors that do not participate in sponsoring the stock-based compensation plan for investee

employees are also impacted. Such investors would recognize their respective share of the expense

recorded by the investee as part of the share of earnings or losses of the investee. In addition, as the

investee would have recorded an increase in its capital, the other non-contributing investors would

also record their share of the investee’s increase in net assets as part of their share of earnings or

losses, with a corresponding increase in their equity method investment. The accounting is described

in ASC 323-10-25-3 through ASC 323-10-25-5. See SC 7.2.7 for further information.

ASC 323-10-25-3

Paragraphs 323-10-25-4 through 25-6 provide guidance on accounting for share-based payment

awards granted by an investor to employees or nonemployees of an equity method investee that

provide goods or services to the investee that are used or consumed in the investee’s operations when

no proportionate funding by the other investors occurs and the investor does not receive any increase

in the investor's relative ownership percentage of the investee. That guidance assumes that the

investor's grant of share-based payment awards to employees or nonemployees of the equity method

investee was not agreed to in connection with the investor's acquisition of an interest in the investee.

That guidance applies to share-based payment awards granted to employees or nonemployees of an

investee by an investor based on that investor's stock (that is, stock of the investor or other equity

instruments indexed to, and potentially settled in, stock of the investor).

ASC 323-10-25-4

In the circumstances described in paragraph 323-10-25-3, a contributing investor shall expense the

cost of share-based compensation granted to employees and nonemployees of an equity method

investee as incurred (that is, in the same period the costs are recognized by the investee) to the extent

that the investor’s claim on the investee’s book value has not been increased.

ASC 323-10-25-5

In the circumstances described in paragraph 323-10-25-3, other equity method investors in an

investee (that is, noncontributing investors) shall recognize income equal to the amount that their

interest in the investee’s net book value has increased (that is, their percentage share of the

contributed capital recognized by the investee) as a result of the disproportionate funding of the

compensation costs. Further, those other equity method investors shall recognize their percentage

share of earnings or losses in the investee (inclusive of any expense recognized by the investee for the

stock-based compensation funded on its behalf).

ASC 323-10-55-19 through ASC 323-10-55-26 includes a comprehensive example that demonstrates

an investor’s accounting for stock-based compensation awarded to employees of an equity method

investee by the investor.


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ASC 323-10-55-19

This Example illustrates the guidance in paragraphs 323-10-25-3 and 323-10-30-3 for share-based

compensation by an investor granted to employees of an equity method investee. This Example is

equally applicable to share-based awards granted by an investor to nonemployees that provide

goods or services to an equity method investee that are used or consumed in the investee’s

operations.

ASC 323-10-55-20

Entity A owns a 40 percent interest in Entity B and accounts for its investment under the equity

method. On January 1, 20X1, Entity A grants 10,000 stock options (in the stock of Entity A) to

employees of Entity B. The stock options cliff-vest in three years. If an employee of Entity B fails to

vest in a stock option, the option is returned to Entity A (that is, Entity B does not retain the

underlying stock). The owners of the remaining 60 percent interest in Entity B have not shared in

the funding of the stock options granted to employees of Entity B on any basis and Entity A was not

obligated to grant the stock options under any preexisting agreement with Entity B or the other

investors. Entity B will capitalize the stock-based compensation costs recognized over the first year

of the three-year vesting period as part of the cost of an internally constructed fixed asset (the

internally constructed fixed asset will be completed on December 31, 20X1).

ASC 323-10-55-21

Before granting the stock options, Entity A’s investment balance is $800,000, and the book value of

Entity B’s net assets equals $2,000,000. Entity B will not begin depreciating the internally

constructed fixed asset until it is complete and ready for its intended use and, therefore, no related

depreciation expense (or compensation expense relating to the stock options) will be recognized

between January 1, 20X1, and December 31, 20X1. For the years ending December 31, 20X2, and

December 31, 20X3, Entity B will recognize depreciation expense (on the internally constructed

fixed asset) and compensation expense (for the cost of the stock options relating to Years 2 and 3 of

the vesting period). After recognizing those expenses, Entity B has net income of $200,000 for the

fiscal years ending December 31, 20X1, December 31, 20X2, and December 31, 20X3.

ASC 323-10-55-22

Entity C also owns a 40 percent interest in Entity B. On January 1, 20X1, before granting the stock

options, Entity C’s investment balance is $800,000.

ASC 323-10-55-23

Assume that the fair value of the stock options granted by Entity A to employees of Entity B is

$120,000 on January 1, 20X1. Under Topic 718, the fair value of share-based compensation should

be measured at the grant date. This Example assumes that the stock options issued are classified as

equity and ignores the effect of forfeitures.

ASC 323-10-55-24

Entity A would make the following journal entries.

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(a) Entity A recognizes as an expense the portion of the costs incurred that benefits the other

investors (in this Example, 60 percent of the cost or $24,000 in 20X1, $36,000 in 20X2, and

$12,000 in 20X3) and recognizes the remaining cost (40 percent) as an increase to the investment

in Entity B. As Entity B has recognized the cost associated with the stock-based compensation

incurred on its behalf, the portion of the cost recognized by Entity A as an increase to its investment

in Entity B (40 percent) is expensed in the appropriate period when Entity A recognizes its share of

the earnings of Entity B.

(b) It may be appropriate to classify the debit (expense) within the same income statement caption as

equity in earnings of Entity B.

(c) This amount represents Entity C’s 40 percent interest in the additional paid-in capital recognized

by Entity B related to the cost incurred by the third party investor. It may be appropriate to classify

the credit (income) within the same income statement caption as equity in earnings of Entity B.

12/31/20X1 12/31/20X2 12/31/20X3

To record cost of stock compensation and Entity C’s additional Investment for costs incurred by Entity A on behalf of investee

Entity A (Contributing Investor)

Investment in Entity B(a) $ 16,000 $ 16,000 $ 16,000

Expenses (b) 24,000 24,000 24,000

Additional paid-in capital $40,000 $40,000 $40,000

Entity B (investee)

Fixed asset $ 40,000 — —

Expenses — $ 40,000 $ 40,000

Additional paid-in capital $ 40,000 $ 40,000 $ 40,000

Entity C (noncontributing Investor)

Investment in Entity B $ 16,000 $ 16,000 $ 16,000

Contribution income(c) $ 16,000 $ 16,000 $ 16,000

To record Entity A’s and Entity C’s share of the earrings of investee (same entry for both Entity A and Entity C)

Entity A and Entity C


Equity in earrings of Entity B $ 80,000 $ 80,000 $ 80,000

Consolidated impact of all the entries made by Entity A and Entity C

Entity A


Expenses 24,000 24,000 24,000

Additional paid-in capital $ 40,000 $ 40,000 $ 40,000

Equity in earrings of Entity B 80,000 80,000 80,000

Entity C


Contribution income $16,000 $16,000 $16,000

Equity in earrings of Entity B 80,000 80,000 80,000


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4.4 Lag in investee reporting

The financial statements of an investee may not be available for the investor to apply the equity

method as of the current reporting date. For example, the investor and investee may both have a

reporting period ending on March 31, but the investor might not receive the investee’s financial

statements for several months. The investor can make an accounting policy election to record its share

of the earnings or losses of the investee using a lag period of one to three months. The lag should be

applied consistently from period to period.

The decision to record an investee’s results on a lag can be made on an investment-by-investment

basis. Therefore, each investment should be assessed separately to determine if a lag in investee

reporting is necessary.

While ASC 323 does not specify a limit on the extent of the lag period, the provisions relating to

consolidation of subsidiaries with different fiscal year ends than its parent entities offer a reasonable

guideline (i.e., three months).

ASC 810-10-45-12

It ordinarily is feasible for the subsidiary to prepare, for consolidation purposes, financial statements

for a period that corresponds with or closely approaches the fiscal period of the parent. However, if the

difference is not more than about three months, it usually is acceptable to use, for consolidation

purposes, the subsidiary’s financial statements for its fiscal period; if this is done, recognition should

be given by disclosure or otherwise to the effect of intervening events that materially affect the

financial position or results of operations.

When results of the investee are reported on a lag, the investee results should be for the same length of

time as what is included in the investor’s financial statements. For example, for an investor’s annual

financial statements, the investee’s results for 12 months should be included, although the results are

for a different 12 months than those of the investor’s standalone results. Including the investee’s

results for a period greater or less than 12 months in the investor’s annual financial statements is

generally not appropriate. A time lag in reporting should be consistent from period to period. See EM

4.4.1 for information regarding the investor’s accounting for a new investment that is reported on a

lag.

The investor should consider the effect of any known events occurring during the lag period that

materially affect the financial position or results of operations of the investee if those events are also

material to the financial position or results of operations of the investor.

An investor may elect to either (1) disclose or (2) disclose and record adjustments for material events

occurring during the intervening period. This policy should be applied on a consistent basis from one

period to the next. Often reporting entities choose disclosure only for material intervening events as it

may be challenging to determine a threshold for when to adjust for intervening events. The investor

would also need to track adjustments to ensure it does not record its share of intervening events in

subsequent periods.


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4.4.1 Initial lag period

An investor may elect to include the investee’s results on a lag for an investment in an investee for

which it will apply the equity method for the first time. The investor would include its share of the

investee earnings from the date of acquisition through the end of the date selected for lag reporting in

the investor’s first reporting period. Example EM 4-3 illustrates an investor’s accounting for the

acquisition of an equity method investment that is reported with a lag period.

EXAMPLE EM 4-3

Acquisition of equity method investment reported with a lag

Investor, a public company with a calendar year end, acquires an equity method investment in

Investee on December 1, 20X1, which will be accounted for on a two-month lag.

How should Investor record its share of Investee’s earnings for 20X1 and 20X2?

Analysis

In its annual 20X1 financial statements, Investor would record the acquisition of its interest in

Investee at cost. However, Investor would not record any share of Investee earnings despite having

owned the investment for the month of December.

In its first quarter 20X2 financial statements, Investor would include its share of Investee earnings for

December 20X1 and January 20X2. Investor’s share of Investee earnings for the year ended 20X2

would include 11 months (December 1, 20X1 to October 31, 20X2).

4.4.2 Sale of interest when reporting on a lag

When an investor disposes of all or a portion of its investment in an investee that it reported on a lag,

it should generally reflect its share of the investee earnings in net income only up to the end of the date

selected for lag reporting. An investor would usually record its gain or loss on sale of the investment

when it is sold, and would not record the disposal on a lag.

Example EM 4-4 illustrates the sale of an interest in an investee after the lag period.

EXAMPLE EM 4-4

Sale of interest in an investee after the lag period

Investor, a public company with a calendar year end, has an equity method investment in Investee,

which it accounts for on a three-month lag. Investor sells its equity investment in Investee on July 1,

20X2.

How should Investor record its share of Investee’s earnings through the date of sale?

Analysis

In its first and second quarter 20X2 financial statements, Investor would record its share of Investee’s

earnings for the three months ended December 31, 20X1 and March 31, 20X2, respectively. In the


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third quarter, Investor would record its share of Investee’s earnings for the three-months ended June

30, 20X2. Investor would also recognize the gain or loss in earnings on the sale of Investee in its third

quarter 20X2 financial statements.

In Example EM 4-4, the investor sold its investment in the investee at the commencement of a lag

period (i.e., July 1, 20X2). In this instance, the investor did not have to address how to record the

investee’s earnings from the end of the previous quarter’s lag period (i.e., June 30, 20X2) through the

date of the sale. However, in most cases, an investor does not sell its investment at the commencement

of the lag period. An investor should consider how to record its share of the investee’s earnings

through the sale date in order to not record earnings for a period greater than the investor’s reporting

period. Example EM 4-5 illustrates an acceptable view as to how the investor would record the sale of

an interest in an investee during the lag period.

EXAMPLE EM 4-5

Sale of interest in an investee during a lag period

Investor, a public company with a calendar year end, has an equity method investment in Investee,

which it accounts for on a three-month lag. Investor sells its equity investment in Investee on

September 30, 20X2.

How should Investor record its share of Investee’s earnings through the date of sale?

Analysis

In the absence of a sale, Investor would record its share of Investee’s earnings for the three months

ended June 30, 20X2 in the third quarter ended September 30, 20X2 because of the lag in recording

its share of Investee’s earnings. However, recording a gain determined using Investor’s June 30, 20X2

investment balance would effectively result in also recording Investee earnings for the three-months

ended September 30, 20X2 (i.e., the sales proceeds, based on the September 30, 20X2 fair values,

would have considered Investee’s earnings for the three-months ended September 30, 20X2).

Recording earnings for the three-months ended June 30, 20X2 under Investor’s lag reporting as well

as effectively recording Investee earnings for the three-months ended September 30, 20X2 through

the gain on sale would inappropriately result in a total of six months of Investee earnings recognized in

Investor’s third quarter financial statements.

In order to only record three-months of earnings in the third quarter, Investor could analogize to the

accounting for the elimination of a lag period when the earliest period presented would be adjusted.

For example, in this case, Investor would record Investee’s earnings for the three-months ended June

30, 20X2 as an adjustment to beginning retained earnings. See EM 4.4.3 for further information on

the accounting for changes to a lag in investee reporting.

4.4.3 Change to lag in investee reporting

The change or elimination of a lag between investor and investee reporting periods is considered a

change in accounting principle. The investor is required to demonstrate preferability before making

the change. In addition, public companies are required to obtain a preferability letter from the

investor’s independent auditor when the change is material. See FSP 30.4 for a discussion of changes

in accounting principles.


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ASC 810-10-45-13

A parent or an investor should report a change to (or the elimination of) a previously existing

difference between the parent’s reporting period and the reporting period of a consolidated entity or

between the reporting period of an investor and the reporting period of an equity method investee in

the parent’s or investor’s consolidated financial statements as a change in accounting principle in

accordance with the provisions of Topic 250. While that Topic generally requires voluntary changes in

accounting principles to be reported retrospectively, retrospective application is not required if it is

impracticable to apply the effects of the change pursuant to paragraphs 250-10-45-9 through 45-10.

The change or elimination of a lag period represents a change in accounting principle as defined in

Topic 250. The scope of this paragraph applies to all entities that change (or eliminate) a previously

existing difference between the reporting periods of a parent and a consolidated entity or an investor

and an equity method investee. That change may include a change in or the elimination of the

previously existing difference (lag period) due to the parent’s or investor’s ability to obtain financial

results from a reporting period that is more consistent with, or the same as, that of the parent or

investor. This paragraph does not apply in situations in which a parent entity or an investor changes

its fiscal year-end.

Generally, retrospective application is required under ASC 250 unless impracticable to apply the

effects of the change. Therefore, for the elimination of a lag period, an investor should adjust its

financial statements for all periods presented as if the reporting lag never existed. For example,

assume Investor, a calendar year end public company, eliminated the existing three-month reporting

lag in the fourth quarter 20X1. Investor would adjust its 20X1 financial statements to reflect its share

of investee’s earnings for the twelve months ended December 31, 20X1. Investor would reverse its

share of Investee’s earnings for the three months ended December 31, 20X0, which, absent the

elimination of the lag, would have been recognized in its 20X1 financial statements. Such amounts

would be recorded as a direct adjustment to the current period opening retained earnings balance as if

recognized in the prior period.

In practice, it is difficult to justify the preferability of a change that creates (or lengthens) a lag period.

The inability to obtain timely information when historically able to do so is unusual, and is generally

not on its own a sufficient reason for introducing a lag in reporting. Further, the inability to obtain

timely financial information may indicate that the investor does not have the ability to exert significant

influence over an investee and the applicability of the equity method of accounting should be

reevaluated (see EM 2 for a further discussion).

4.4.4 Availability of public information

If an investee is a public entity, certain laws may preclude an investor from disclosing information

about a public investee that is not already publicly available. This can occur when the investee’s

financial statements are not due to be filed until after the investor’s financial statements. As a result,

the investor may elect to report its investment in the investee on a lag, provided such lag does not

exceed three months.

Similarly, even when an investor elects the fair value option for an investment in a public company

that would otherwise qualify for the equity method, it may be difficult to provide the required equity

method disclosures for that investee. Even though fair value is determined at the end of the current

reporting period, it may be appropriate to provide the disclosures based on the most recent publicly

available financial statements, as long as the lag does not exceed three months.

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4.5 Losses in excess of investment carrying amount

An investor’s share of losses of an investee (including any impairments of its investment as discussed

in EM 4.8) may exceed the carrying amount of its investment (including unsecured or subordinated

intercompany advances made by the investor other than accounts receivable in the ordinary course of

business). It is appropriate to consider deferred intercompany profits (as discussed in EM 4.2) as a

reduction in the carrying amount of the investment. The investor should also consider any other

comprehensive income (OCI) amounts recorded by the investor that relate to its equity method

investment. We believe that the equity method investment carrying amount should include the effects

of any OCI amounts, except for OCI related to foreign currency translation adjustments.

There is a general presumption that equity method should be suspended and losses should not be

recognized in excess of the total investment (including any additional advances). It is important that

investors continue to track unrecognized equity method losses to determine when to record

subsequent period equity method earnings. See EM 4.5.3 for further discussion.

An investor may record losses in excess of the carrying amount of the investment if the investor has

guaranteed the investee’s obligations or has committed to provide further financial support to the

investee, as described in ASC 323-10-35-20.

ASC 323-10-35-20

The investor ordinarily shall discontinue applying the equity method if the investment (and net

advances) is reduced to zero and shall not provide for additional losses unless the investor has

guaranteed obligations of the investee or is otherwise committed to provide further financial support

for the investee.

Judgment should be exercised when assessing if the investor is committed to provide further financial

support for the investee and should be based on an analysis of the related facts and circumstances. The

following are factors that should be considered in making this assessment:

□ Legal and quasi-legal obligations

When the investor is legally obligated to assume, underwrite, or guarantee investee obligations, an

investor would recognize losses in excess of the its investment.

When an investor has guaranteed investee obligations, it may need to record losses allocable to the

other investors instead of only its proportionate share of the investee’s losses. If the investor is

legally obligated to fund more than its portion of the investee losses (i.e., other investors are not

obligated to fund losses), the investor will generally be required to record investee losses otherwise

allocable to other investors, since it is likely that such other investors will not bear their share.

When the other investors are obligated to fund a proportionate share, the investor should assess

the ability of the other investors to fund if necessary, not the probability that the investee will

require funding. If it is probable that the other investors will not fund their portion of the investee

losses, the investor is required to record the entire loss of the investee up to its legal obligation

(i.e., beyond its proportionate share). This could occur when the other investors, while legally

obligated to provide support, choose not to or lack the financial capability to fund.


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Investors should also consider joint and several liability arrangements under which the lender can

demand payment of the total amount from any one of the obligors (investors) or combination of

obligors. While the investor may be able to pursue payment from the other investors, it again

would need to consider the likelihood that the other investors would be able to fund their

respective obligations. The accounting for joint and several liability arrangements is contained in

ASC 405-40. See FG 2 for further information on the accounting for joint and several liability

arrangements.

Losses in excess of the investment should ordinarily be recognized when the investor has a “quasi-

legal” obligation to underwrite investee losses. A quasi-legal obligation is based on factors other

than a strict obligation, such as the business relationship and credit standing of the other

investors. When the investor has followed the practice of underwriting investee losses through

advances, or there is a strong presumption that the investor would “make good” the obligations of

an investee in order to preserve its credit rating, business reputation, or other important

relationships, recognition of losses may be required even without a legally binding obligation. This

determination requires judgment and may be based predominantly on the intent of the investor.

When the investor has previously acted upon that intent by funding the investee, it would be

difficult to support a change in intent not to fund the investee, absent the occurrence of a change

in business strategy.

The investor must consider whether the other investors also have a quasi-legal obligation and will

bear their share of the losses. This is necessary to determine whether the investor should record

losses otherwise allocable to other investors, in addition to its allocated losses. The requirements

of ASC 460 should be considered as they relate to such guarantees.

To the extent an investor is funding the losses of an investee, the investor should consider the

provisions of the variable interest entity model to determine whether the investee may be a VIE

and require consolidation by the investor. The funding of losses may also require reconsideration

of previous consolidation conclusions under ASC 810-10.

□ Publicly stated investor intentions

Public statements by the investor of its intention to abandon, or to continue to provide support to,

an investee should be considered.

□ Operating considerations

Operating matters should be considered to the extent practicable. The following circumstances

may indicate the investor is unlikely to abandon the investee and, therefore, full recognition of

losses in excess of the investor’s investment is appropriate:

o Investee losses are attributable to start-up costs, or similar circumstances that are considered

temporary or nonrecurring, and a turnaround to profitable operations is expected.

o The investee may be in an industry in which accounting losses can be sustained more or less

indefinitely without impairing the going concern assumption (e.g., real estate development

companies).

o The operation experiencing losses may integrate favorably with other consolidated operations.


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o The investor is a major supplier to or major purchaser from the investee.

o The investor is dependent on the investee for strategic development processes (for example,

research and development or new technologies).

o Any other factors indicating that the investor has an incentive to protect and support the

investee.

The key consideration from an operating perspective is whether the investor would abandon the

investee. This assessment is based on the investor’s relationship with the investee and the other

investors and should consider all relevant facts and circumstances.

Losses are also required to be recognized by an investor in excess of its investment when the imminent

return to profitability by the investee is assured. This determination requires the exercise of judgment.

This differs from consolidation guidance in ASC 810-10, which requires losses to continue to be

attributed to the noncontrolling interest even if that results in a debit balance.

ASC 323-10-35-21

An investor shall, however, provide for additional losses if the imminent return to profitable

operations by an investee appears to be assured. For example, a material, nonrecurring loss of an

isolated nature may reduce an investment below zero even though the underlying profitable operating

pattern of an investee is unimpaired.

4.5.1 Change of interest after suspension of equity method losses

An investor should consider whether a subsequent investment in an investee after the investor has

suspended recognizing equity method losses provides the investor with a controlling financial interest

in the investee. If the investor gains a controlling financial interest in the investee, the investor would

follow the acquisition guidance in ASC 805. See EM 5 for further discussion on the accounting for

changes in interest.

When an additional investment does not provide an investor with a controlling financial interest, the

investor should consider whether the additional investments, in substance, represent the funding of

prior losses versus an additional investment. The investor should recognize previously suspended

losses only up to the amount of the additional investment determined to represent the funding of prior

losses. The investor should also consider whether it has otherwise become committed to provide

financial support to the investee when making an additional investment.

Whether an investment represents the funding of prior losses depends on the facts and circumstances.

Judgment is required to determine whether prior losses are being funded. All available information

should be considered in performing the related analysis. ASC 323 provides additional factors for

consideration.

ASC 323-10-35-29

If a subsequent investment in an investee does not result in the ownership interest increasing from

one of significant influence to one of control and, in whole or in part, represents, in substance, the

funding of prior losses, the investor should recognize previously suspended losses only up to the


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amount of the additional investment determined to represent the funding of prior losses (see (b)).

Whether the investment represents the funding of prior losses, however, depends on the facts and

circumstances. Judgment is required in determining whether prior losses are being funded and all

available information should be considered in performing the related analysis. All of the following

factors shall be considered; however, no one factor shall be considered presumptive or determinative:

a. Whether the additional investment is acquired from a third party or directly from the investee. If

the additional investment is purchased from a third party and the investee does not obtain

additional funds either from the investor or the third party, it is unlikely that, in the absence of

other factors, prior losses are being funded.

b. The fair value of the consideration received in relation to the value of the consideration paid for

the additional investment. For example, if the fair value of the consideration received is less than

the fair value of the consideration paid, it may indicate that prior losses are being funded to the

extent that there is disparity in the value of the exchange.

c. Whether the additional investment results in an increase in ownership percentage of the investee.

If the investment is made directly with the investee, the investor shall consider the form of the

investment and whether other investors are making simultaneous investments proportionate to

their interests. Investments made without a corresponding increase in ownership or other

interests, or a pro rata equity investment made by all existing investors, may indicate that prior

losses are being funded.

d. The seniority of the additional investment relative to existing equity of the investee. An investment

in an instrument that is subordinate to other equity of the investee may indicate that prior losses

are being funded.

4.5.2 Investor holds other investments in the investee

When an investor has investments outside its equity method investment, such as preferred stock and

loans, the investor would continue to recognize investee losses up to the investor’s aggregate carrying

value in those other investments. The recognition of losses would include any additional financial

support made or committed to by the investor. An investment considered to be in-substance common

stock may generally be grouped with, and considered, common stock for the purposes of performing

the investee loss allocations required.

ASC 323-10-35-25

The cost basis of the other investments is the original cost of those investments adjusted for the effects

of write-downs, unrealized holding gains and losses on debt securities classified as trading in

accordance with Subtopic 320-10 or equity securities accounted for in accordance with Subtopic 321-

10 and amortization of any discount or premium on debt securities or financing receivables. The

adjusted basis is the cost basis adjusted for the allowance for credit losses account recorded in

accordance with Topic 326 on measurement of credit losses for an investee financing receivable and

debt security and the cumulative equity method losses applied to the other investments. Equity

method income subsequently recorded shall be applied to the adjusted basis of the other investments

in reverse order of the application of the equity method losses (that is, equity method income is

applied to the more senior investments first)


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Equity method losses should be applied to other investments based on seniority, beginning with the

most subordinated investments. For each period, the basis of the other investments should first be

adjusted for equity method losses and may need to be further adjusted after applying the relevant

impairment guidance for those investments. For example, assume an investor invests in both common

stock and preferred stock of an investee and made advances to the investee in the form of debt.

Subsequently, if the investor’s share of equity method losses reduces the basis of its common stock

investment to zero, the investor should continue to recognize equity method losses to the extent of,

and as an adjustment to, the basis of the preferred stock (the next most senior security). The advance

to the investee in the form of debt would continue to be accounted for in accordance with the

provisions of an impairment of a loan by a creditor. However, once the cost basis of the investment in

the preferred stock also reaches zero, investee losses would be recognized to the extent that the net

carrying amount of the debt (net of any valuation account or amortization) exceeded zero. At all times,

the preferred stock would require a write-up (or write-down) to fair value through income if it is an

equity security as defined in ASC 321 (absent applying the measurement alternative) or through OCI if

it is a debt security as defined in ASC 320 (and reported as available for sale).


[T]he investor shall continue to report its share of equity method losses in its statement of operations

to the extent of and as an adjustment to the adjusted basis of the other investments in the investee.

The order in which those equity method losses should be applied to the other investments shall follow

the seniority of the other investments (that is, priority in liquidation). For each period, the adjusted

basis of the other investments shall be adjusted for the equity method losses, then the investor shall

apply Subtopic 310-10, 320-10, 321-10, 326-20, or 326-30 to the other investments, as applicable.

When an investor’s investment in common stock has been reduced to zero and it has other

investments in the investee, the investor generally should not recognize incremental equity method

losses against its other investments based only on percentage of investee common stock held in

accordance with ASC 323-10-35-28. There are two acceptable methods that could be applied. An

investor would either recognize investee losses based on (1) the ownership level of the particular

investee security or loan/advance held by the investor to which the equity method losses are being

applied, or (2) the change in the investor’s claim on the investee book value. Once elected, one method

should be applied consistently for all equity method investments.

Example EM 4-6 illustrates the approach to attribute investee losses based on ownership level of the

particular investee security or loan/advance held by the investor. EM 4.1.3 includes an example of a

change in the investor’s claim on the investee book value from ASC 323-10-55-49.

EXAMPLE EM 4-6

Attribution of investee losses when investor has other investment

On January 1, 20X1, Company XYZ began its operations with three investors, Company A, Company B,

and Company C.

• Company A acquired 1,000,000 shares of Company XYZ’s common stock for $1 per share and

loaned Company XYZ $1,000,000 in cash.

http://www.pwccomperio.com/contents/english/external/us/gaap/310/310-10.htm

http://www.pwccomperio.com/contents/english/external/us/gaap/320/320-10.htm


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• Company B acquired 750,000 shares of Company XYZ’s common stock for $1 per share and

1,000,000 shares of Series A voting preferred stock in Company XYZ for $2 per share. The

preferred stock is not considered in-substance common stock.

• Company C acquired 750,000 shares of Company XYZ’s common stock for $1 per share.

Company A, Company B, and Company C account for their respective investments in common stock

under the equity method of accounting.

For simplicity, this example assumes the preferred stock is measured using the measurement alternative with no observable changes in fair value or impairment under ASC 321, Investments – Equity Securities, and the loan was not impaired under ASC 310, Receivables.

Company A Company B Company C Total

Common stock (shares) 1,000,000 750,000 750,000 2,500,000

Percent of common stock ownership 40% 30% 30% 100%

Preferred stock (shares) — 1,000,000 — 1,000,000

Total shares 1,000,000 1,750,000 750,000 3,500,000

Percent of total voting shares outstanding 28.6% 50.0% 21.4% 100%

Total value of shares outstanding $1,000,000 $2,750,000 $750,000 $4,500,000

Loan 1,000,000 — — 1,000,000

Total investment in company XYZ $2,000,000 $2,750,000 $750,000 $5,500,000

Company XYZ incurred losses of $2,500,000 and $2,750,000 in 20X1 and 20X2, respectively. None of

Company XYZ’s investors is required to provide additional financial support. Assume that Company

XYZ is not a VIE.

What are Company A, Company B, and Company C’s respective shares of Company XYZ’s losses for

20X1 and 20X2?

Analysis

The following table illustrates how Company A, B, and C should account for the losses in Company XYZ for 20X1 and 20X2, given their investments in Company XYZ.

Company A

Common stock

Loan

Equity investment in Company XYZ - 1/1/20X1 $1,000,000 $1,000,000

Company A’s share of 20X1 net losses (($2,500,000) × 40%) (1,000,000)

—

Equity investment in Company XYZ - 12/31/20X1 (a) —

1,000,000



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Company A’s share of 20X2 net losses ($750,000) [that is, $2,750,000 less $2,000,000 that is first applied to preferred stock] —

(750,000)

Equity investment in Company XYZ - 12/31/20X2 (b) —

250,000

Company B

Common stock

Preferred stock

Equity investment in Company XYZ - 1/1/20X1 $750,000

$2,000,000

Company B’s share of 20X1 net losses (($2,500,000) × 30%) (750,000)

—


2,000,000

Company B’s share of 20X2 net losses [that is, $2,750,000, of which $2,000,000 is first applied to preferred stock] —

(2,000,000)


—

Company C

Common stock

Equity investment in Company XYZ - 1/1/20X1 $750,000

Company C’s share of 20X1 of net losses (($2,500,000) × 30%) (750,000)


Company C’s share of 20X2 net losses —


a – In 20X1, Company XYZ’s losses ($2,500,000) should be allocated proportionately to the common

stock held by Companies A, B, and C. As a result, at December 31, 20X1, the investment balance of

Companies A, B, and C in the common stock of Company XYZ have all been reduced to zero due to the

allocation of their proportionate share of Company XYZ’s net loss. This allocation was based on the

percentage of common stock owned by each investor, not on the percentage ownership of total voting

stock. As noted above, the preferred stock is not in-substance common stock for purposes of this

example.

b – Because each company’s equity investment in Company XYZ is zero, in 20X2, the $2,750,000 net

loss must be allocated to the next most senior level of capital (the $2,000,000 of preferred stock held

by Company B), and then the remaining amount ($750,000) is allocated to Company A’s loan.

Accordingly, at December 31, 20X2, Company B’s preferred stock investment in Company XYZ has


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been reduced to zero since the $2,750,000 net loss is first applied against the preferred stock

investment, as it is the next most senior investment . Similarly, at December 31, 20X2, Company A’s

loan investment in Company XYZ has been reduced to $250,000 since the remaining portion of

Company XYZ’s net loss ($750,000) is applied against the loan investment balance.

4.5.3 Investee return to profitability

When the investor does not recognize investee losses in excess of its investment and the investee

returns to profitability and subsequently reports net income or OCI, the investor generally should

resume applying the equity method, absent any investee capital transactions, only after the investee’s

shareholders’ deficit is eliminated (i.e., once the investor has equity in the net assets of the investee).

This requires the investor to continue to track its unrecorded share of investee losses during the period

the equity method has been suspended.

The “share of net losses not recognized” should be the aggregate of the investor’s share of investee

losses and any adjustments related to subsequent accounting for basis differences (see EM 4.3.1) that

would have been charged to income during the period when losses were not recognized.


b. 2. If the adjusted basis reaches zero, equity method losses shall cease being reported; however, the

investor shall continue to track the amount of unreported equity method losses for purposes of

applying paragraph 323-10-35-20. If one of the other investments is sold at a time when its carrying

value exceeds its adjusted basis, the difference between the cost basis of that other investment and its

adjusted basis at the time of sale represents equity method losses that were originally applied to that

other investment but effectively reversed upon its sale. Accordingly, that excess represents unreported

equity method losses that shall continue to be tracked before future equity method income can be

reported.

When an investee returns to profitability, an investor generally restores its investment balance only to

the extent of the investor’s equity in net assets of the investee. Therefore, an investor would generally

not restore the remaining balance of any unamortized basis differences that were not recognized after

losses reduced the investor’s investment balance to zero.

Example EM 4-7 illustrates the methodology that is generally employed when an investor restores its

investment balance after (1) an investor does not recognize investee losses in excess of its investment

balance and (2) an investee returns to profitability.

EXAMPLE EM 4-7

Prior losses in excess of investment not recognized

Investor pays $100 for a common stock investment in Investee and determines that it is able to

exercise significant influence over Investee. At the date of acquisition, Investor’s share of Investee net

assets is $70. Investor determines that the $30 excess cost over net assets of Investee (initial basis



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difference) relates entirely to a manufacturing plant. The basis difference assigned to the plant is being

depreciated on a straight-line basis over 10 years.

Investee has incurred losses for the first three years. Investor’s share of those losses amounted to $40 per year. Investee is profitable in year four and five and Investor’s share is $70 in each of those years.

Date

Investor share of Investee

income (loss)

Depreciation of basis

difference

Equity in net income of Investee (loss)

reported by Investor

Period-end investment

balance

Composition of ending investment

Equity element

Basis difference

1/1/20X1 $ - $ - $ - $100 $70 $30

12/31/20X1 (40) (3) (43) 57 30 27

12/31/20X2 (40) (3) (43) 14 (10) 24

12/31/20X3 (40) (3) (14) — (50) 0

12/31/20X4 70

20 20 20 0

12/31/20X5 70

70 90 90 0

In year 3, Investor recorded losses that reduced the carrying amount of its investment to zero,

resulting in the elimination of the remaining unamortized basis difference.

In year four, Investor restored its investment only to the extent of Investor’s equity in net assets of

Investee. Investor did not restore the unamortized basis difference related to the plant. Therefore, for

the year ending 12/31/20X4, Investor’s proportionate share of Investee’s net income is limited to $20

($20 = ($50) + $70).

If an investor had other investments (e.g., preferred stock) in the investee entity when equity method

losses had also been recorded as an adjustment to these investments, the investor’s share of investee’s

earnings in a subsequent return to profitability should first be applied to those other investments in

reverse order (i.e., starting with the most senior investment).

4.6 Interest costs related to equity method investment

An investor should consider interest costs related to equity method investments. ASC 835-20 requires

an investor to capitalize interest costs while the investee has activities in progress to begin planned

principal operations and the investee is using funds to acquire assets for its operations. Interest cannot

be capitalized after the planned principal operations have commenced, for example, when an investee

has several factories under construction but one begins operations.


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Excerpt from 835-20-15-5

Interest shall be capitalized for the following types of assets (qualifying assets)…

c. Investments (equity, loans, and advances) accounted for by the equity method while the investee has

activities in progress necessary to commence its planned principal operations provided that the

investee’s activities include the use of funds to acquire qualifying assets for its operations. The

investor’s investment in the investee, not the individual assets or projects of the investee, is the

qualifying asset for purposes of interest capitalization.

Excerpt from 835-20-15-6

Interest shall not be capitalized for the following types of assets…

d. Investments accounted for by the equity method after the planned principal operations of the

investee begin (see paragraph 835-20-55-2 for clarification of the phrase after planned principal

operations begin)

Separately, an investee may qualify to capitalize interest on allowable projects in its own financial

statements, even if the investor is not permitted to capitalize the interest it incurs. The investor would

recognize interest capitalized by the investee through its equity method earnings (i.e., its

proportionate share of the depreciation expense related to the investee’s capitalized interest).

However, if the investee’s capitalized interest is related to a loan from the investor, the investor should

adjust equity method earnings for its proportionate share of capitalized interest from its equity

method investment with a related deduction from its equity method investment. Example EM 4-8

illustrates this concept.

EXAMPLE EM 4-8

Investee capitalizes interest costs for loan from investor

Investor has a 25% investment in Investee common stock that is accounted for under the equity

method of accounting. On 1/1/20X1, Investor loans $1 million with a 6% annual interest rate to

Investee to build a factory. Investee does not have any other loans outstanding. Investee’s planned

principal operations have not yet commenced, and so the related interest qualifies for capitalization

per ASC 835-20. Investee has net income for the year ending 12/31/20X1 of $300,000.

How should Investor record its share of Investee’s earnings?

Analysis

Investor would record its 25% share of Investee’s earnings for the year ending 12/31/20X1 as follows.

Dr. Equity method investment $75,000

Cr. Equity method earnings $75,000

Investor would also record $60,000 of interest income for the year ending 12/31/20X1 ($1,000,000

loan balance multiplied by 6% annual interest rate).

Dr. Cash $60,000

Cr. Interest income $60,000


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Investee has capitalized the interest associated with the loan provided by Investor. Therefore, Investor

needs to adjust equity method earnings to deduct Investor’s proportionate share of the interest

capitalized by Investee (25% of $60,000 total Investee interest).

Dr. Equity method earnings $15,000

Cr. Equity method investment $15,000

This example does not consider the effect of any basis differences on the factory resulting from

Investee being able to capitalize interest that is not capitalizable by Investor. The investor should

consider the effects of basis differences that arise from capitalized interest on loans from the investor

and should adjust equity method earnings over the same period of the associated underlying assets of

the investee (e.g., depreciation of the related PP&E).

Investors should evaluate if loans to the investee are considered in-substance capital contributions,

such as a scenario when all investors are required to make loans or advances in proportion to their

equity interests. If an in-substance capital contribution, interest received by the investor would be

accounted for as a distribution from the investee, with a reduction to the investor’s equity method

investment instead of interest income.

ASC 835-20-30-6 limits the total interest cost to be capitalized by a consolidated group to the interest

incurred by the parent and its consolidated subsidiaries. An equity method investee is not a part of the

investor’s (parent’s) consolidated group. Therefore, interest incurred by the investee is not eligible for

capitalization by the investor. Similarly, interest incurred by the investor is not capitalizable by the

investee.

4.7 Distributions in excess of carrying amount of investment

An investor may receive cash distributions in excess of the carrying amount of its investment. We

believe that an investor should account for cash distributions received in excess of its investment in an

investee as a gain when (a) the distributions are not refundable by agreement or by law and (b) the

investor is not liable for investee obligations and is not committed or expected to provide financial

support. Otherwise, the investor should account for the excess distribution as a liability. Whether an

investor has a non-legal commitment to provide financial support to an investee depends on the facts

and circumstances surrounding an investor's relationship with the investee and other investors. The

considerations in assessing whether a non-legal obligation exists are similar to those set forth in EM

4.5.

If a general partner has an equity method investment in a limited partnership and receives cash

distributions in excess of its investment balance, the excess distributions are recorded as a reduction of

its partnership interest, even if it results in a negative net investment (liability). This treatment,

consistent with ASC 970-323, is due to the general partner's ongoing obligation to support the

partnership. Alternatively, for a limited partner investor, gain recognition may be appropriate if it does

not have an obligation (by agreement or law) or intent to fund future cash flow requirements of the

partnership.

If an investor records an excess distribution from an equity method investee as income, the investor

should generally not record its share of any subsequent investee income until it equals the gain


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recorded. This approach is similar to the method applied for the recovery of unrecorded excess losses

by the investor in ASC 323-10-35-22. If an investor records an excess distribution from an equity

method investee as a liability (negative investment), the investor should record its portion of any

subsequent investee income as equity method income.

4.8 Impairment of an equity method investment

An investor is required to assess its equity method investment for impairment when events or

circumstances suggest that the carrying amount of the investment may be impaired.

4.8.1 Loss in investment value that is other than temporary

An investor records an impairment charge in earnings when the decline in value below the carrying

amount of its equity method investment is determined to be other than temporary. “Other than

temporary” does not mean that the decline is of a permanent nature. The unit of account for assessing

whether there is an other-than-temporary impairment (OTTI) is the carrying value of the equity

method investment as a whole.

ASC 323-10-35-32

A loss in value of an investment that is other than a temporary decline shall be recognized. Evidence of

a loss in value might include, but would not necessarily be limited to, absence of an ability to recover

the carrying amount of the investment or inability of the investee to sustain an earnings capacity that

would justify the carrying amount of the investment. A current fair value of an investment that is less

than its carrying amount may indicate a loss in value of the investment. However, a decline in the

quoted market price below the carrying amount or the existence of operating losses is not necessarily

indicative of a loss in value that is other than temporary. All are factors that shall be evaluated.

Continued operating losses at the investee may suggest that the investor would not recover all or a

portion of the carrying value of its investment, and therefore that the decline in value is other than

temporary.

ASC 323-10-35-31

A series of operating losses of an investee or other factors may indicate that a decrease in value of the

investment has occurred that is other than temporary and that shall be recognized even though the

decrease in value is in excess of what would otherwise be recognized by application of the equity

method.

All available evidence should be considered in assessing whether a decline in value is other than

temporary. The relative weight placed on individual factors may vary depending on the situation.

Factors to consider in assessing whether a decline in value is other than temporary include:

□ The length of time (duration) and the extent (severity) to which the market value has been less

than cost.

□ The financial condition and near-term prospects of the investee, including any specific events

which may influence the operations of the investee, such as changes in technology that impair the


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earnings potential of the investment or the discontinuance of a segment of the business that may

affect the future earnings potential.

□ The intent and ability of the investor to retain its investment in the investee for a period of time

sufficient to allow for any anticipated recovery in market value.

Investors should also consider the reasons for the impairment and the period over which the

investment is expected to recover. The longer the expected period of recovery, the stronger and more

objective the positive evidence needs to be in order to overcome the presumption that the impairment

is other than temporary. As the level of negative evidence grows, more positive evidence is needed to

overcome the need for an impairment charge. The positive evidence should be verifiable and objective.

Figure EM 4-2 contain examples of negative evidence that may suggest that a decline in value is other

than temporary. Figure EM 4-3 contains examples of positive evidence that may suggest a decline in

value is not other than temporary. These examples are not all-inclusive, and investors should assess all

relevant facts and circumstances.

Figure EM 4-2 Negative evidence that indicates decline is other than temporary

□ A prolonged period during which the fair value of the security remains at a level below the

investor’s cost

□ The investee’s deteriorating financial condition and a decrease in the quality of the investee’s

asset, without positive near-term prospects for recovery. For example, adverse changes in key

ratios and/or factors, such as the current ratio, quick ratio, debt to equity ratio, the ratio of

stockholders’ equity to assets, return on sales, and return on assets. With respect to financial

institutions, examples of adverse changes are large increases in nonperforming loans, repossessed

property, and loan charge-offs.

□ The investee’s level of earnings or the quality of its assets is below that of the investee’s peers

□ Severe losses sustained by the investee in the current year or in both current and prior years

□ A reduction or cessation in the investee’s dividend payments

□ A change in the economic or technological environment in which the investee operates that is

expected to adversely affect the investee’s ability to achieve profitability in its operations

□ Suspension of trading in the security

□ A qualification in the accountant’s report on the investee because of the investee’s liquidity or due

to problems that jeopardize the investee’s ability to continue as a going concern

□ The investee’s announcement of adverse changes or events, such as changes in senior

management, salary reductions and/or freezes, elimination of positions, sale of assets, or

problems with equity investments

□ A downgrading of the investee’s debt rating


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□ A weakening of the general market condition of either the geographic area or industry in which the

investee operates, with no immediate prospect of recovery

□ Factors, such as an order or action by a regulator, that (1) require an investee to (a) reduce or scale

back operations or, (b) dispose of significant assets, or (2) impair the investee’s ability to recover

the carrying amount of assets

□ Unusual changes in reserves (such as loan losses, product liability, or litigation reserves), or

inventory write-downs due to changes in market conditions for products

□ The investee loses a principal customer or supplier

□ Other factors that raise doubt about the investee’s ability to continue as a going concern, such as

negative cash flows from operations, working-capital deficiencies, or noncompliance with

statutory capital requirements

□ The investee records goodwill, intangible or long-lived asset impairment charges

Figure EM 4-3 Positive evidence indicating decline is not other than temporary

□ Recoveries in fair value subsequent to the balance sheet date

□ The investee’s financial performance and near-term prospects (as indicated by factors such as

earnings trends, dividend payments, analyst reports, asset quality, and specific events)

□ The financial condition and prospects for the investee’s geographic region and industry

In situations where the fair value is known, such as in the case of an investment with a quoted price or

when an investee stock transaction occurs, and that fair value is below the investor’s carrying amount,

the investor would need to assess whether that impairment is other than temporary. The fact that the

fair value is below the carrying amount does not automatically require an impairment charge to be

recognized. All facts and circumstances would need to be considered.


A current fair value of an investment that is less than its carrying amount may indicate a loss in value

of the investment. However, a decline in the quoted market price below the carrying amount or the

existence of operating losses is not necessarily indicative of a loss in value that is other than

temporary. All are factors that shall be evaluated.

For investments in private companies, information that would usually be considered includes:

□ The price per share of the most recent round of equity investments

□ The expected timing of the next round of financing

□ The history of operating losses and negative cash flow

□ Earnings and cash flow outlook and expected cash burn rate


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□ Technological feasibility of the company’s products

Once a determination is made that an OTTI exists, the investment should be written down to its fair

value in accordance with ASC 820 at the reporting date, which establishes a new cost basis. Any

bifurcation of declines in value between “temporary” and “other than temporary” is not allowed.

Subsequent declines or recoveries after the reporting date are not considered in the impairment

recognized. A previously recognized OTTI also cannot subsequently be reversed when fair value is in

excess of the carrying amount.

When an investor records an OTTI charge, the investor is required to attribute the impairment charge

to the underlying equity method memo accounts of its investment. The attribution may create new

basis differences or impact existing basis differences. ASC 323 does not provide guidance on

attributing the amount of an OTTI charge to the investor’s equity method memo accounts. We believe

there are several acceptable methods to attribute the charge; however, the method applied should be

reasonable given the nature of the OTTI charge. Two acceptable methods include the specific

identification method and the fair value method. Under the specific identification method, the investor

would create a new basis difference or adjust an existing one for the specific items (e.g., litigation) that

resulted in the OTTI charge. Under the fair value method, the investor would reset all its basis

difference as if the investor had acquired the investment on the date of recording the OTTI charge.

Example EM 4-9 illustrates the adjustment of an existing basis difference under the specific

identification method.

EXAMPLE EM 4-9

Subsequent accounting for negative basis differences created by an impairment charge

In 20X1, Investor acquired a 40% investment in Investee (a public company) for $25 million. At the

date of the acquisition, the book value of the net assets of Investee totaled $50 million and the fair

value of the net assets totaled $62.5 million. The assets held by Investee consisted primarily of net

current assets with a carrying value and fair value of $30 million and long-lived assets with remaining

useful lives of 10 years, a carrying value of $20 million, and a fair value of $32.5 million. As a result,

the carrying value of Investor’s proportionate interest in the net assets of Investee was $20 million.

The $5 million basis difference was attributed entirely to fixed assets.

Five years later (i.e., in year 20X6), Investee lost the contract of a significant customer and

experienced some production issues. No impairment charge was recorded within Investee’s financial

statements (impairment was tested under the long-lived asset impairment model using the

undiscounted future cash flows, which were in excess of the book value of the assets). However, the

market price per share of Investee declined below Investor’s investment balance per share,

representing a potential impairment of $5 million. Based on all available information, Investor

concluded that the decline in value of Investee’s market price per share was other than temporary. For

simplicity, all tax implications are ignored.

How should Investor subsequently account for negative basis differences created by an impairment

charge?


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Analysis

Assuming Investor determines that the decline in value of $5 million is other than temporary, Investor

would record an impairment charge of $5 million against the investment in Investee.

Given the nature of Investee’s operations and asset base (principally working capital and fixed assets),

this loss could be considered attributable to Investee’s fixed assets. As a result, the impairment charge

would eliminate the remaining fixed asset basis difference of $2.5 million ($5.0 million × 5/10 years

amortized), and create an additional $2.5 million negative basis difference.

The negative basis difference would be amortized over the remaining asset lives. Investor would need

to determine the appropriate amortization period. While there are 5 years remaining of the original

10-year useful life determined at the date of the initial investment, the estimated remaining lives of

Investee’s fixed assets at the date of impairment should be considered in determining the appropriate

amortization period. For this example, we have assumed 5 years.

Investee’s net income would include $2,000,000 of depreciation expense ($20,000,000 [investee’s

carrying value of its fixed assets]/10 years [estimated useful life]), which reflects the carrying value of

the fixed assets as reported in Investee’s financial statements. Investor would recognize its

proportionate share of Investee’s net income; however, Investor should also amortize $500,000 ($2.5

million/5 years) of the negative basis difference as an increase (credit) to equity method earnings in

order to reflect Investor’s lower cost basis in Investee’s fixed assets, which results in lower annual

depreciation expense.

4.8.2 Cumulative translation adjustment balance in impairment

An investor may have an equity method investment in, or within, a foreign entity and a related

cumulative translation adjustment balance. Unless an entity has committed to a plan that would cause

reclassification of some amount of CTA into earnings (i.e., the equity method investment is a part of

disposal group classified as held for sale), any effects from foreign currency translation adjustments

should be excluded from the carrying value of an equity method investment when assessing it for

impairment. See FX 8.4.

4.8.3 Impairment considerations when reporting on a lag

Fair value is determined at the reporting date for the purposes of an impairment, regardless of

whether the investor accounts for the investment on a lag.

4.8.4 Impairments recorded at the investee level

An investor applying the equity method does not need to separately test the investee’s underlying

assets for impairment (or the value it has recorded in its equity method memo accounts related to

those assets). Equity method goodwill is also not required to be separately assessed for impairment.

ASC 350 indicates that the impairment guidance is not applicable to an investor applying the equity

method on the basis that the investor does not control the business or underlying assets that give rise

to the goodwill.


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If the investee recognizes an impairment charge, including for goodwill, then the investor would

generally need to record at least its share of that impairment charge. An impairment charge at the

investee may also impact the investor’s basis differences in those impaired assets.

The investor and investee often apply different impairment models and at a different unit of account −

impairment is tested at the investment level under the equity method of accounting compared to

individual asset groups by the investee. Therefore, an impairment charge may need to be recorded at

the investor level where no impairment exists at the investee level. This could eliminate or create a

new basis difference.

Chapter 5:Accounting for changes in interest or influence

Accounting for changes in interest or influence

5-2

5.1 Overview of changes in interest

An investor with an existing interest in an investee may acquire an additional interest, or dispose of

part of its interest, resulting in a change to its ownership interest. A change in ownership interest may

cause an investment:

□ not previously accounted for under the equity method to qualify for the equity method for the first

time,

□ accounted for using the equity method, to be adjusted to reflect a gain or loss in interest, while

continuing to be accounted for under the equity method, or

□ an investment to cease qualifying for the equity method of accounting and become subject to other

accounting guidance.

When an investee undertakes a capital transaction, such as when issuing or purchasing its shares, the

investor’s ownership interest may change, even though the investor did not directly acquire or sell an

additional interest in the investee. Like investor transactions, investee transactions can have an

accounting impact for the investor.

Finally, even when there is no change in the investor’s ownership interest, amendments to governing

documents or other terms of the arrangement may impact the level of influence or control that an

investor has, which can also impact the investor’s accounting for its investment.

The reassessment of whether an investor has significant influence or control over the investee is an

ongoing evaluation. EM 2 addresses whether an investor has significant influence and CG 1 addresses

whether an investor has control.

See FSP 10.4.3 for information on the presentation of an investment that qualifies for the equity

method of accounting.

5.2 Determining applicable change in interest guidance

A change in the investor’s ownership interest can arise from transactions entered into by the investor,

the investee, or some combination thereof. Additionally, even where the investor does not obtain or

dispose of an interest in the investee, a change in the level of influence or control can cause an investor

to revisit how it accounts for its investment.

How an investor should account for a change in an ownership interest is dependent upon how the

investment was accounted for prior to the change in interest, and what the appropriate accounting will

be after the change.

5.2.1 Increase in ownership or influence in an investee

The ownership interest of an investor may increase when it purchases additional shares from a third

party, or as a result of capital transactions undertaken by an investee. Additionally, an investor may

gain significant influence or control of an investee, such as when there is an amendment to the

agreements governing the arrangement. Figure EM 5-1 outlines the possible scenarios that can occur


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when the proportional ownership interest of an investor increases, or the investor gains significant

influence or control.

Figure EM 5-1 Accounting for an increase in ownership or influence in an investee

Change in interest Impact to investor Discussed in

Prior accounting: Fair value or measurement alternative (ASC 321)

New accounting: Equity method (ASC 323)

Assuming fair value option not elected:

• Recognize investment at investor’s current basis of previously held interests plus cost of incremental investment, if any.

• Determine basis differences for the entire investment.

EM 5.3.1

Prior accounting: Equity method (ASC 323)

New accounting: Continue to apply equity method (ASC 323)

Recognize cost for incremental investment (cost accumulation), determine basis differences arising on acquisition of new “step” interest using fair values of underlying investee assets and liabilities on the acquisition date.

Prospectively recognize investor’s share of equity investee’s earnings based on new ownership interest, adjusted for the effects of new and previous basis differences, and other items.

EM 5.3.2


Future accounting: Consolidate (ASC 810)

Remeasure the previously-held equity method investment (and any other previously-held interests) at fair value and recognize any difference to the carrying amount in net income.

Recognize 100% of identifiable assets and liabilities, including the:

• recognition of NCI, if any, at fair value

• recognition of 100% of goodwill or bargain purchase gain

EM 5.3.3

5.2.2 Decrease in ownership or influence in an investee

The ownership interest of an investor may decrease when it sells shares to a third party, or as a result

of capital transactions undertaken by an investee. Additionally, an investor may lose significant

influence or control of an investee as a result of changes to the arrangement. Figure EM 5-2 outlines

each of the possible scenarios that can occur when the ownership interest of an investor decreases, or

the investor loses significant influence or control.


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Figure EM 5-2 Accounting for a decrease in ownership or influence in an investee

Change in interest Impact to investor Discussed in

Prior accounting: Consolidate (ASC 810)

New accounting: Equity method (ASC 323)

Deconsolidate investment and remeasure retained investment (noncontrolling interest) at fair value. Gain or loss recognized in net income.

Assuming fair value option not elected:

• Retained investment (remeasured at fair value) forms initial cost basis of equity method investment. Determine basis differences.

• Prospectively recognize investor’s share of equity investee’s earnings based on retained interest, adjusted for the effects of basis differences, and other items.

EM 5.4.1


New accounting: Continue to apply equity method (ASC 323)

Recognize gain or loss for the difference between the proceeds from the sale and the investor’s carrying amount of the equity method investment.

OCI balances associated with the portion of the equity method investment that was disposed of must be recycled from OCI through net income.

Prospectively recognize investor’s share of equity investee’s earnings based on new interest, adjusted for the effects of basis differences, and other items.

EM 5.4.2


New accounting: Fair value or measurement alternative (ASC 321)


OCI balances associated with the equity method investment must be recycled from OCI through net income.

The investor’s initial carrying amount of any retained common stock or in-substance common stock investment would include its proportionate share of previously recognized earnings or losses of the investee.

EM 5.4.3


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New accounting: N/A. Investor disposes of entire interest


AOCI balances associated with the equity method investment must be recycled from OCI through net income.

EM 5.4.4

5.2.3 Investee treasury transactions

A change in interest can arise from an investee capital transaction, such as an issuance or purchase of

shares by the investee. The issuance of additional shares by an investee results in a decrease in

ownership by the investor and has the same accounting effect as a direct sale of investee shares by the

investor. Conversely, a repurchase of shares by an investee results in an increase in ownership by the

investor and has the same accounting effect as a direct purchase of investee shares by the investor.

ASC 323-10-35-15

A transaction of an investee of a capital nature that affects the investor’s share of stockholders’ equity

of the investee shall be accounted for on a step-by-step basis.

Accordingly, an investor should consider capital transactions of an investee that result in a change in

interest in a manner similar to how the investor evaluates its own purchases and sales of the investee

stock. See EM 5.2.1 and EM 5.2.2 for an outline of possible scenarios.

Stock-based compensation awarded by an investee to its own employees is addressed in EM 4.3.6. The

investor recognizes its portion of the investee’s compensation expense through the investor’s

recognition of its portion of the investee’s earnings. A basis difference would be created, as the

investee’s net equity would not be affected as a result of the stock award (i.e., dr. compensation

expense, cr. APIC). Additionally, when an employee exercises its option, the employee consideration to

the investee in return for the shares would include the total compensation expense previously

recognized, along with the employee exercise price, and should be accounted for following the

appropriate dilution scenario as described in EM 5.2.2.

Unique investee transactions, including those with noncontrolling shareholders, those with entities

under common control, and those that do not result in a change in interest are addressed in EM 5.6.

5.2.4 Noncash transactions

An investor may increase its ownership interest through the contribution of noncash assets to the

investee. See EM 3.2.4 for a discussion of when noncash assets are used to acquire an investment.

Similarly, when an investor transfers all or a portion of its equity method investment, the criteria in

ASC 860-10-40-5 must be met in order to qualify for derecognition of the equity method investment

and recognition of the associated gain or loss. This is because equity method investments are financial

assets and therefore transfers of equity method investments are within the scope of ASC 860. The

criteria in ASC 860 are further explained in TS 3. If the exchange is economically a dilution event, the

issuer (investee) is deemed to have effectively issued additional shares to other investors. Such an


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exchange is not in the scope of ASC 860 and the change in interest guidance outlined in EM 5.2.1 and

EM 5.2.2 would be applicable.

5.2.5 Fair value option

ASC 825-10, Financial Instruments, allows entities to elect to account for certain financial

instruments using the fair value option, as discussed in FV 5.

An entity electing to adopt the fair value option for any of its equity method investments is required to

present those equity method investments at fair value at each reporting period, with changes in fair

value reported in the income statement. In addition, certain disclosures are required in the investor’s

financial statements when it has elected the fair value option for an investment that otherwise would

be accounted for under the equity method of accounting. See FSP 20.6.3.2 for these disclosure

requirements.

The election of the fair value option is irrevocable unless an event creating a new election date occurs.

Therefore, absent a qualifying event, a reporting entity that elects to adopt the fair value option to

account for an equity method investment is precluded from subsequently applying the equity method

of accounting to that investment.

5.2.5.1 Eligibility to elect the fair value option

As described in ASC 825-10-25-4, an investor may elect to apply the fair value option when an

investment becomes subject to the equity method of accounting for the first time. For example, an

investment would become subject to the equity method of accounting for the first time when an

investor obtains significant influence by acquiring an additional investment in an investee, or when an

investor loses control of an investee but retains an interest that provides it with the ability to exercise

significant influence.


An entity may choose to elect the fair value option for an eligible item only on the date that one of the

following occurs...

d. The accounting treatment for an investment in another entity changes because the investment

becomes subject to the equity method of accounting.

An investor may elect to apply the fair value option to an equity method investment irrespective of the

types of assets held by the equity method investee.

An investor that elects the fair value option and subsequently loses the ability to exercise significant

influence would be required to continue to account for its retained interest on a fair value basis. That

is, if it were subject to ASC 321, the entity could not elect to apply the measurement alternative but

must continue to account for the instrument using the fair value option. An investor is precluded from

applying the fair value option for a consolidated entity.

A reporting entity can generally elect the fair value option for a single eligible investment without

needing to elect the fair value option for identical types of investments in other investees. That is, an

instrument-by-instrument election is allowed. However, when an investor elects to apply the fair value


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option for an equity method investment, it must apply the fair value option to all of its eligible

interests in the same investee (e.g., all tranches of equity, debt investments, guarantees), including any

previously held interest.

Although equity method investments are generally eligible to be accounted for under the fair value

option, doing so would not always be appropriate. Specifically, when an equity method interest

includes a significant compensatory element and the investor is not required to separately account for

the compensatory element, the investor should not elect the fair value option for its equity investment.

For example, an equity method investment may include terms that provide one investor with a

disproportionate allocation of returns in return for providing management services to the investee. In

such cases, election of the fair value option would not be appropriate, as it could accelerate revenue

that should be earned when future services are provided to the investee.

5.3 Increase in ownership, influence, or control

There are a number of potential scenarios in which the ownership interest of an investor increases or

an investor gains significant influence or control over an investee. These may include an investment

that was:

□ previously accounted for by applying ASC 321, and will now qualify for the equity method for the

first time (see EM 5.3.1),

□ accounted for using the equity method, that will be adjusted to reflect an increase in interest, and

will continue to be accounted for under the equity method (see EM 5.3.2), and

□ previously accounted for under the equity method but which the investor should now consolidate

(see EM 5.3.3).

5.3.1 Previously applied ASC 321 and will now apply equity method

An investor holding an investment that is accounted for in accordance with ASC 321 will be required to

apply equity method accounting to that investment if it gains significant influence (see EM 2). In

addition to obtaining significant influence through its own actions (e.g., purchasing additional

common stock), an investor may also gain significant influence as a result of investee transactions, as

further explained in EM 5.2.3.

An entity that is required to adopt the equity method of accounting should do so prospectively from

the date significant influence is obtained. Under ASC 323-10-35-33, an investor should add the cost of

acquiring the additional interest in the investee (if any) to the carrying amount of its previously held

interest.

ASC 323-10-35-33

Paragraph 323-10-15-12 explains that an investment in common stock of an investee that was

previously accounted for on other than the equity method may become qualified for use of the equity

method by an increase in the level of ownership described in paragraph 323-10-15-3 (that is,

acquisition of additional voting stock by the investor, acquisition or retirement of voting stock by the

investee, or other transactions). If an investment qualifies for use of the equity method (that is, falls

within the scope of this Subtopic), the investor shall add the cost of acquiring the additional interest in




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the investee (if any) to the current basis of the investor’s previously held interest and adopt the equity

method of accounting as of the date the investment becomes qualified for equity method accounting.

The current basis of the investor’s previously held interest in the investee shall be remeasured in

accordance with paragraph 321-10-35-1 or 321-10-35-2, as applicable, immediately before adopting

the equity method of accounting. For purposes of applying paragraph 321-10-35-2 to the investor’s

previously held interest, if the investor identifies observable price changes in orderly transactions for

an identical or a similar investment of the same issuer that results in it applying Topic 323, the entity

shall remeasure its previously held interest at fair value immediately before applying Topic 323.

An investor may have accounted for its previously held interest at fair value as further explained in LI

2.3. In such cases, the investor should remeasure its investment at fair value through earnings prior to

adding the cost of the additional investment (if any) and accounting for the investment as an equity

method investment.

Alternatively, an investor may have accounted for its previously-held interest using the measurement

alternative described in ASC 321-10-35-2 (see LI 2.3.3 for an explanation of the measurement

alternative). In such cases, prior to transitioning to equity method accounting, an entity should

consider whether an orderly transaction exists that would necessitate a remeasurement of its existing

ASC 321 investment. Shares purchased by an investor that cause it to account for its investment using

the equity method represent an observable transaction if they were identical or similar to the existing

investment that was accounted for using the measurement alternative and the shares were purchased

in an orderly transaction. See LI 2.3.2.2 for a discussion of whether instruments should be deemed

similar and what constitutes an orderly transaction. Only after considering whether remeasurement is

warranted should the entity add the cost of the additional investment (if any) and account for the

investment as an equity method investment.

ASU 2020-01 clarifies that a forward or option to purchase shares that will be accounted for as an

equity method investment should be accounted for under ASC 321. A forward or an option with no

intrinsic value at acquisition should be measured at fair value at exercise or settlement even if the

measurement alternative is elected based on the guidance in ASC 815-10-35-6. While the scope of ASC

815-10-15-141 and ASC 815-10-15-141A does not include options with intrinsic value at acquisition, we

generally believe the guidance should also be applied to options with intrinsic value. See LI 2.3.2.3 for

a discussion of options or forwards accounted for under ASC 321.

ASC 323 does not provide specific guidance on how basis differences should be determined and

allocated to the equity method investment when the investor had a previous interest that was

accounted for in accordance with ASC 321. There are several reasonable and acceptable methods to

determine and allocate any basis differences. For example, assume an investor that holds a 15%

interest in the investee acquires an additional 10% interest resulting in the investor having significant

influence over the investee. The investor may treat the total carrying value of its 25% investment in the

investee as the cost of acquiring its 25% equity method investment and determine and allocate basis

differences accordingly. Notwithstanding, when the fair value of the acquired assets is greater than the

cost basis of the investment, a bargain purchase should not be recognized. See EM 3.3.7 for a

discussion of how to treat situations that would result in a bargain purchase gain. See EM 4.3.1 for

information on the subsequent accounting of basis differences.

5.3.2 Obtain additional interest and continue to apply equity method

An investor’s proportional ownership in the investee may increase when the:

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□ investor buys additional shares from third parties (see EM 5.3.2.1),

□ investee issues new shares and investor buys more than the proportion it previously held making

it a “net purchaser” (see EM 5.3.2.2), or

□ investee buys shares as treasury stock and the investor sells less than its proportionate ownership

in the investee making it a “net purchaser” (see EM 5.3.2.3).

When an investor acquires an additional interest, either directly or indirectly, there will generally be a

difference between (a) the cost of the investor’s incremental share of the investee’s net assets and (b)

its interest in the investee’s carrying value of those net assets. Whenever an investor increases its

ownership interest in an investee, the investor should identify and recognize any new basis differences.

Any unassigned difference would be designated as equity method goodwill in the equity method memo

accounts if the investee is a business. In some cases, the sum of the amounts assigned to assets

acquired and liabilities assumed can exceed the cost of the acquired investee interest (excess over

cost). In such cases, an investor should not recognize a bargain purchase gain (see EM 3.3.7 for further

discussion).

The previously held interests and related equity method memo accounts are not revisited in

connection with a step acquisition. Accordingly, the equity method memo account for each asset and

liability will reflect the sum of the basis differences for each incremental acquisition associated with


After the acquisition, the investor will adjust its share of earnings and losses of the investee not only

for the impact of basis differences that arose from the initial investment but also those arising from

each step (i.e., subsequent investment). See EM 4.3.1 for a discussion of subsequent accounting for

basis differences.

Whenever an additional interest is obtained, the investor should first determine whether it has

obtained a controlling financial interest, as further discussed in EM 5.3.3.

5.3.2.1 Investor purchases shares from third parties

An investor that applies the equity method of accounting may increase its ownership interest in the

investee by purchasing additional shares. Incremental purchases of common stock or in-substance

common stock from third parties are recorded at cost. Basis differences should be determined as

described in EM 5.3.2.

5.3.2.2 Investee sells additional shares and investor is net purchaser

When the investee sells additional shares of its stock and the investor buys a greater proportion of the

shares offered than its pre-sale proportionate ownership, the investor is a “net purchaser” as its post-

transaction percentage ownership interest increases. Said differently, the investor has effectively

purchased additional shares at a cost that is more or less than the investee book value. The investor

would account for the net effect of the purchase in the same manner as if the shares were acquired

from a third party, which includes establishing any basis difference in its memo accounts (see EM

3.3.1).


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Example EM 5-1 illustrates a scenario in which an investee sells shares and the investor is a net

purchaser.

EXAMPLE EM 5-1

Investee sells additional shares and investor is a net purchaser

Investee has 120 shares of common stock outstanding. Investor A, Investor B, and Investor C each own

40 shares or 33% of the Investee. Investee issues 35 additional shares for cash consideration at a price

greater than the Investee’s carrying value per share. Investor A and B each purchase 10 shares and

Investor C purchases 15 shares. Total outstanding shares after the transaction is 155 shares.

How should Investor C account for the acquisition of 15 shares?

Analysis

Investor C would reflect an increase in the carrying amount of its investment to reflect the cost of the

first 10 of its 15 new shares. Investor C would not reflect any incremental basis difference for those

shares as Investor A, Investor B, and Investor C each maintained their same ownership interest.

Investor C would record a new incremental basis difference to reflect the 3.2% interest (5 shares /155

shares) it acquired in the Investee through the 5 shares it purchased in excess of the other investors.

Investor C should determine the cost of the 5 shares and allocate that cost to its 3.2% incremental

interest in the net assets of Investee. The difference between its cost and the carrying value of the

investee’s net assets should be reflected as an incremental basis difference.

5.3.2.3 Investee purchases shares and investor is net purchaser

When an investee buys treasury stock and the investor does not sell shares, the investor is a “net

purchaser” as its ownership interest in the investee increases. This transaction is effectively an indirect

acquisition by the investor and is similar to when an investor acquires shares of the investee directly

from other investors. Accordingly, the investor will need to identify any basis differences created as a

result of its ownership percentage increase.

One way to determine the basis difference is to consider the investee purchase of treasury stock and

the increase in the investor’s ownership percentage as two transactions. Any cash proceeds received

from the investee would reduce the investor’s investment balance. Subsequently, the investor will be

deemed to have indirectly acquired an additional interest and should determine the applicable basis

differences using that incremental cost.

Example EM 5-2 illustrates a scenario when an investee purchases its own shares at a price greater

than their carrying amount, and the investor reflects a change in basis resulting from the decrease in

the investee’s carrying amount.

EXAMPLE EM 5-2

Investee purchases shares and investor is a net purchaser

Investor owns 40 common shares in Investee representing a 40% ownership interest (a total of 100

shares are outstanding). The carrying value of the investment on Investor’s books is $10 per share,


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which is also Investee’s book value per share (i.e., no basis differences exist). Investee subsequently

purchases 25 shares from third parties at $12 per share in a treasury stock transaction. The price

exceeds Investee’s book value per share of $10.

As a result of this transaction, Investor’s ownership interest in Investee has increased from 40% to

53.3% (40 shares/75 shares). Investor, as a result of not selling any of its ownership interest has, in

substance, purchased an additional interest in Investee. Investor does not obtain control of Investee.

How should Investor record the transaction?

Analysis

Investee’s initial net assets of $1,000 were reduced by the $300 paid by Investee to purchase 25 shares

from third parties at $12 per share. Accordingly, the Investor’s proportionate interest in the Investee’s

net assets is now $373 (53.3% × $700). As Investor’s carrying amount of $400 is unchanged, Investor

will need to identify basis differences of $27, which represents the amount by which its carrying

amount exceeds the Investee's carrying amount.

This could also be determined by calculating the excess decrease in Investee’s carrying amount

attributable to the repurchase of the shares from third parties of $50 ($2 per share ($12 - $10) * 25

shares) multiplied by Investor’s proportionate interest of 53.3%, which results in a difference of $27.

The $27 basis difference should be allocated to the newly acquired 13.3% interest in the net assets of

the Investee.

Investee would reflect a treasury stock transaction in its stand-alone financials.

5.3.3 Previously applied equity method and will now consolidate

An investor should no longer apply the equity method of accounting to an investee entity if it gains a

controlling financial interest over the investee. An investor could gain control of an investee entity as a

result of:

□ a direct or indirect change in its level of ownership interest,

□ a change to a contractual arrangement or to the investee’s governing documents, or

□ the expiration of a contractual relationship or the resolution of a contingency.

The determination of whether consolidation is required in accordance with the variable interest entity

(VIE) model is something that can change over the life of an investment. Even if the investee was not

initially determined to be a VIE, an investor is required upon the occurrence of certain events to

reassess whether or not an entity is, in fact, a VIE, as discussed in CG 2.3.4. Alternatively, if the

investee was previously determined to be a VIE, but the investor was determined not to be the primary

beneficiary, the investor is required to perform the primary beneficiary analysis each subsequent

reporting date, as discussed in CG 2.4.8.

When a reporting entity obtains control of a legal entity, the method of consolidation will vary

depending on whether the entity is a VIE, or meets the definition of a business, as described in CG 2.5.


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See BCG 5.4 for information on the acquisition method when an investor gains control of a financial

interest that is deemed a business combination.

5.4 Decrease in ownership, influence, or control

There are a number of potential scenarios in which the ownership interest of an investor decreases or

the investor loses significant influence or control. These may include:

□ an investment that was previously consolidated but will now qualify for the equity method (see EM

5.4.1),

□ an existing equity method investment in which the investor’s ownership interest decreased,

however, it will continue to be accounted for under the equity method (see EM 5.4.2),

□ an investment that was previously accounted for under the equity method, but it will now be

accounted for under ASC 321 (see EM 5.4.3), or

□ an investment that was previously accounted for under the equity method, but it has been fully

disposed of (see EM 5.4.4).

5.4.1 Previously consolidated but now applying equity method

An investor should reassess, on an ongoing basis, whether it has lost control of an investee.

An investor may lose a controlling financial interest over the investee but retain a noncontrolling

investment in common stock or in-substance common stock that gives it significant influence over that

investee entity. In such situations the investor should apply the equity method to its retained interest.

Change of interest transactions that result in the investor losing control generally result in the

recognition of a gain or loss in net income for the sale of the controlling interest and the

remeasurement of any retained noncontrolling investment at fair value. See BCG 5.5 for a discussion

of change in interest transactions that result in a loss of control. If the controlling interest is a

nonfinancial asset or in substance a nonfinancial asset as described in PPE 6.2.2.5, then the criteria

described in PPE 6.2.4 must also be met before the investee may be deconsolidated.

When an investor applies the equity method to a retained interest in a previously consolidated

investee, the fair value of the retained interest forms the basis for the initial measurement. Basis

differences arise if the fair value of the investment differs from the investor’s proportionate share in

the carrying amount of the investee’s net assets.

When changing from consolidation to the equity method, the investee is consolidated until the point

when control is lost, and the equity method is applied from that point forward.

5.4.2 Interest reduced but will continue to apply equity method

An investor that applies the equity method of accounting may reduce its ownership interest in the

investee by selling a portion of its shares or through an investee transaction (see EM 5.2.3).


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When an investor disposes of a portion of an equity method investment, the investor will need to

determine the applicable gain or loss on disposition. A gain or loss on disposal is recorded when the

selling price per share is more or less than the investor’s carrying amount per share.

In determining the gain or loss, the carrying amount of shares sold should generally be calculated

based on the average carrying amount of all shares held by the investor. Other methods have been

applied in practice, such as the “identified certificate” or FIFO basis; however, the average carrying

amount will often best reflect the economic substance of the disposition. For example, under the

"identified certificate" method, the gain or loss on disposition will be impacted by the specific

certificates that are selected for sale; therefore, this method is not often considered an appropriate

method. It should also be noted that a temporary difference arises when the “identified certificate” or

FIFO basis is used to compute taxable income and the average basis is used to determine the gain or

loss for financial reporting.

No new basis differences would arise as a result of a disposal; basis differences only arise on the

acquisition of an interest in an investee. Notwithstanding, an investor would eliminate the portion of a

preexisting basis difference associated with the portion of the investment sold. The investor would

prospectively adjust its share of earnings and losses of the investee only for the remaining basis

difference.

An investor’s equity method ownership interest in the investee that will continue to be accounted for

using the equity method, will decrease when:

□ the investor sells a portion of its shares to a third party (see EM 5.4.2.1),

□ the investee issues new shares and the investor buys less than its proportionate ownership

interest, making it a “net seller” (see EM 5.4.2.2), or

□ the investee buys shares as treasury stock and the investor sells more than its proportionate

ownership interest in the investee making it a “net seller” (see EM 5.4.2.3).

5.4.2.1 Investor sells a portion of its shares to a third party

An investor that applies the equity method may sell a portion of its interest in the investee to a third

party. For such transactions, the investor should recognize a gain or loss equal to the difference

between the selling price and the carrying value of the interest sold at the time of sale.

In determining the gain or loss in a partial disposition of an equity method investment, the carrying

amount of shares sold should generally be calculated based on the average carrying amount of all

shares held by the investor, as noted in EM 5.4.2.

5.4.2.2 Investee sells unissued shares and investor is a net seller

When an investee sells additional shares and an investor purchases no shares, or purchases less than

its proportionate interest, the investor’s ownership interest in the investee decreases. Such a

transaction is effectively an indirect disposal of part of the investor’s ownership interest. Accordingly,

the investor should recognize a gain or loss equal to the difference between the selling price per share

and the investor’s carrying amount per share.


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Example EM 5-3 illustrates a transaction when the investee issues previously unissued shares at a

price greater than the investor’s carrying amount in the investment and the investor does not buy any

additional shares.

EXAMPLE EM 5-3

Investor is a net seller in investee transaction

Investor owns 40 common shares in Investee representing a 40% ownership interest (a total of 100

shares are outstanding). The carrying value of the investment on Investor’s books is $10 per share,

which is also Investee’s book value per share (i.e., no basis differences exist). Investee subsequently

issues 25 shares at $20 to third parties. This price exceeds Investee’s book value per share of $10.

As a result of this transaction, Investor’s ownership interest in Investee has declined from 40% to 32%

(Investor’s 40 shares/125 shares total shares outstanding).

How should Investor account for the issuance of shares by Investee?

Analysis

The ownership interest of Investor was reduced from 40% to 32% and Investor therefore has in

substance sold a part of its interest in Investee.

Investor’s gain can be calculated as the difference between (a) Investor’s proportionate share of

Investee’s new carrying value (32% x $1,500 = $480) and (2) the carrying value of Investor’s

ownership interest in the Investee prior to the transaction ($400). This would result in a gain of $80,

which could be reflected as a debit to equity method investment and a credit to gain.

Alternatively, Investor’s gain can be thought of as the amount by which its investment increased as a

result of Investee’s issuance of shares to third parties.

Issuance price per share $20

Investor A’s carrying value per share 10

Excess paid over carrying value per share 10

Shares issued x 25

Total excess paid over carrying value per share 250

Investor’s % ownership in Investee x 32%

Investor’s change in interest gain $80

In this example, there were no basis differences. However, if there were, Investor would have to adjust

the memo accounts for the portion of the basis difference sold.


5-15

When the investee issues additional shares as a result of the exercise of employee stock options, the

dilution gain/loss should be calculated similar to Example EM 5-3. However, the consideration

received for the shares issued upon exercise includes any previously recognized compensation expense

plus cash proceeds upon exercise (i.e., exercise price multiplied by the number of shares). See EM

4.3.6 for a discussion of stock compensation awarded by an investee to employees.

5.4.2.3 Investee purchases shares and investor is net seller

When the investee offers to purchase shares from all or some investors in a treasury stock transaction

and the investor sells a proportion greater than its pre-transaction ownership interest, the investor is a

“net seller” as its percentage ownership interest in the investee is decreased (i.e., investor effectively

sells part of its ownership interest in the investee).

An investor may sell a portion of an equity method investment to the investee in an investee treasury

stock transaction. The gain or loss recognized by the investor is equal to the difference between (1) the

proceeds received by the investor in return for the stock sold and (2) the investor’s carrying amount

for the stock sold. If there were basis differences, the investor would have to adjust the memo accounts

for the portion of the basis difference sold.

Example EM 5-4 illustrates the determination of an investor’s gain or loss from an investee treasury

stock transaction.

EXAMPLE EM 5-4

Gain or loss calculation in an investee treasury stock transaction

Investor A owns 200 common shares representing a 50% ownership interest in Investee and accounts

for its investment under the equity method of accounting. The common shares have an aggregate

carrying value on the books of Investor A of $600 and a fair value of $800. Investors B and C each

own 25% of the outstanding common shares of Investee.

Investor A agrees to sell 100 of its shares in Investee (with a fair value of $400) to Investee, which will

be accounted for as a treasury stock transaction in Investee’s financial statements. Investor A has no

basis differences between the carrying amount of its investment and its proportional interest in the

carrying amount of Investee’s net assets.

Immediately prior to the sale by Investor A, the shareholdings of Investee can be summarized as

follows:

Shares Fair value Book value

Investor A 200 shares (50%) $800 $600

Investor B 100 shares (25%) 400 300

Investor C 100 shares (25%) 400 300

Total $1,600 $1,200


5-16

After the sale, Investors A, B, and C each own 100 shares in Investee, resulting in each having a 33%

ownership interest. Investor A’s ownership interest effectively declined from 50% to 33%. Investors B

and C have effectively increased their respective ownership interest from 25% to 33%.

Investee’s net assets have also declined from $1,200 to $800, as it paid Investor A $400 to complete

the transaction.

What is Investor A’s gain on the sale of its shares?

Analysis

Investor A’s gain is $66 calculated as follows:

Proceeds received by Investor A $400

Carrying amount of Investor A’s investment prior to the transaction $600

Carrying amount of Investor A’s investment after the transaction ($800 Investee’s net assets post transaction/3) 266

Reduction in carrying amount 334

Investor’s change in interest gain $66

An alternative way to consider the gain would be to consider a scenario in which rather than providing

a $400 payment to Investor A, Investee made a pro-rata distribution providing $200 to Investor A,

and $100 each to Investor B and C. After the return of the proportionate share of net assets, the

carrying value of Investor A’s interest would have been reduced to $400 ($600-$200).

Investor B and C would then use the cash they received in this hypothetical scenario to purchase

shares from Investor A so that each investor would have a one-third interest. For this to occur,

Investor A would need to sell 67 shares (rounded) for $200, $100 each from Investors B and C. That

would represent 33.5% (67/200 shares) or $134 of Investor A’s basis (33.5% x $400). The gain on sale

recognized by Investor A as a result of the transaction would be $66 ($200 cash received from

Investors B and C less the carrying amount of the shares surrendered which was $134).

Example EM 5-4 was simplified as it presumes no basis difference. Accordingly, the investor’s pre-

transaction investment carrying amount is its proportionate share in the carrying amount of the

investee’s net assets.

In contrast, when the investor’s carrying amount is more or less than its proportionate share in the

carrying amount of the investee’s net assets, additional consideration must be given to the

unamortized basis difference when computing the gain or loss to be recognized in income. Example

EM 5-5 illustrates the determination of a gain or loss when an investor is a net seller in an investee

transaction and there are unamortized basis differences.


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EXAMPLE EM 5-5

Investor is a net seller in an investee transaction

Investee has 100 shares outstanding and equity of $1,000 or $10 per share.

Investor owns 40% (40 of 100 outstanding shares) of Investee and the carrying amount of its

investment is $500. Accordingly, the carrying amount of Investor’s investment exceeds its 40% share

in the carrying amount of Investee’s assets by $100 (Investor’s 40% of Investee’s net assets of $1,000

is a $400 share of Investee net assets). The excess of $100 has been assigned to fixed assets ($60) and

goodwill ($40). See EM 3.3.1 for a discussion of basis differences.

Investee sells 25 newly-issued shares for $500($20 per share). Investor buys no shares and therefore

its ownership interest declines from 40% to 32% (Investor’s 40 shares/125 shares total shares

outstanding). This represents a 20% decline in interest (8%/40%). No portion of the basis difference

was amortized prior to the Investee’s issuance of additional shares.

How should Investor account for the issuance of shares by Investee?

Analysis

Investor’s gain would be computed as follows:

Investor’s share of Investee’s net assets after the transaction (40 shares/125 shares × $1,500 = less)

$480

Investor’s share of Investee’s net assets prior to transaction (40/100 × $1,000) (400)

Gain due to increase in Investee’s net assets $80

Less pro rata write-off of unamortized difference between Investor’s carrying amount and its interest in the Investee’s carrying amount: $100 × 20%

(20)

Change of interest gain $60

The adjustment of the unamortized excess cost should be applied (generally pro rata) to the

unamortized components of the difference. Thus, the $20 would be applied as follows to Investor’s

equity method memo accounts:

Excess assigned to: Before Pro rata

adjustment Pro rata

percentage After

Fixed assets $60 $12 60% $48

Goodwill 40 8 40% 32

$100 $20 $80

Investor would continue to amortize the adjusted amounts of fixed assets prospectively over

appropriate remaining periods.


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5.4.3 Previously applied equity method and will apply ASC 321

An investor may lose significant influence over the investee entity due to the sale of a portion of its

investment, the issuance or purchase of shares by the investee (see EM 5.2.3), or a change to the

investee’s governing documents. The reassessment of whether an investor has significant influence

over the investee entity is an ongoing evaluation.

An investor may lose significant influence when an investee is in legal reorganization or in bankruptcy

or operates under foreign exchange restrictions, controls, or other government-imposed restrictions so

severe that they limit the investor’s ability to exert significant influence over the investee.

Equity method investments are financial assets; therefore, transfers of equity method investments are

within the scope of ASC 860, as further discussed in EM 5.2.4.

If an investor loses significant influence, then the equity method of accounting should be discontinued.

The investor would no longer accrue a share of earnings or losses of the investee from the point that

significant influence is lost. As noted in ASC 323-10-35-36, previously accrued earnings or losses

should not be retroactively adjusted.

ASC 323-10-35-36

An investment in voting stock of an investee may fall below the level of ownership described in

paragraph 323-10-15-3 from sale of a portion of an investment by the investor, sale of additional stock

by an investee, or other transactions and the investor may thereby lose the ability to influence policy,

as described in that paragraph. An investor shall discontinue accruing its share of the earnings or

losses of the investee for an investment that no longer qualifies for the equity method. The earnings or

losses that relate to the stock retained by the investor and that were previously accrued shall remain as

a part of the carrying amount of the investment. The investment account shall not be adjusted

retroactively under the conditions described in this paragraph. Upon the discontinuance of the equity

method, an investor shall remeasure the retained investment in accordance with paragraph 321-10-35-

1 or 321-10-35-2, as applicable. For purposes of applying paragraph 321-10-35-2 to the investor’s

retained investment, if the investor identifies observable price changes in orderly transactions for the

identical or a similar investment of the same issuer that results in it discontinuing the equity method,

the entity shall remeasure its retained investment at fair value immediately after discontinuing the

equity method. Topic 321 also addresses the subsequent accounting for investments in equity

securities that are not consolidated or accounted for under the equity method.

Any of the investee’s OCI recorded in the investor’s financial statements would be reclassified to the

investor’s carrying value of its investment.

ASC 323-10-35-39

In the circumstances described in paragraph 323-10-35-37, an investor’s proportionate share of an

investee’s equity adjustments for other comprehensive income shall be offset against the carrying

value of the investment at the time significant influence is lost. To the extent that the offset results in a

carrying value of the investment that is less than zero, an investor shall both:

a. Reduce the carrying value of the investment to zero

b. Record the remaining balance in income.



5-19

As discussed in ASC 323, the sale of investee shares by an investor generally results in gain or loss

recognition.

ASC 323-10-35-35

Sales of stock of an investee by an investor shall be accounted for as gains or losses equal to the

difference at the time of sale between the selling price and carrying amount of the stock sold.

For the purposes of calculating the gain or loss on the portion of the investment sold, the carrying

amount of the stock sold would include a proportionate share of the investor’s basis differences.

Refer to the financial instruments guidance for any remaining common stock (i.e., ASC 321) or in-

substance common stock investments (i.e., ASC 320 or ASC 321) in the investee. See LI 2 for a

discussion of accounting for equity instruments.

As discussed in ASC 321-10-30-1, the carrying amount of any retained equity interest in the investee

forms the initial basis for which subsequent changes in fair value are measured. If the retained equity

interest has a readily determinable fair value, it should be carried at fair value with changes in value

recorded in net income. Any adjustment to the carrying amount of the retained interest upon the

application of ASC 321 (i.e., to adjust the investment’s carrying amount to fair value) should be

recognized in net income. If the retained equity interest does not have a readily determinable fair

value, it may be eligible for the measurement alternative, as discussed in LI 2.3.2. Entities applying the

measurement alternative must consider all observable transactions, including those that required the

investor to discontinue the equity method of accounting.

Example EM 5-6 illustrates the determination of a gain or loss recognized by an investor upon a sale of

a portion of its interest that results in a loss of significant influence.

EXAMPLE EM 5-6

Loss of significant influence

Investor owns 25 shares representing a 25% ownership interest in Investee, a public entity. Investor

paid $250 for the investment ($10 per share) and accounts for it under the equity method. No basis

differences arose at the time of the acquisition and Investee has had no net income since the

acquisition.

In 20X0, Investee acquired a debt security that it accounted for as available for sale. Investee

recognized a decrease in OCI of $100 for the year due to a decline in the fair value of the security.

Investor recorded its proportionate share of that decrease of $25 (25% of the amount recorded within

Investee’s OCI). As a result, the net carrying value of Investor’s investment in Investee at the end of

the year, including the impact reflected in OCI, was $225 million or $9 per share.

In 20X1, Investor sold 10 shares in Investee to an unrelated third party for $120. At the time of sale,

Investee’s publicly-traded share price was $12 per share. As a result of the sale, Investor’s ownership

percentage decreased from 25% to 15% and it was determined to have lost significant influence. For

illustrative purposes the tax impacts of the transaction have been ignored.

What is the gain or loss recognized by Investor?


5-20

Analysis

Investor would recognize a $20 gain on the sale reflecting the difference between the consideration

received and the associated carrying amount for the portion sold.

Shares

Book value per share Total value

Initial investment 25 $10 $250

Decrease in debt security value (1) (25)

Carrying value of investment prior to sale 25 $9 225

Gain or loss calculation:

Sale of portion of investment (10) $120

Less: adjusted carrying amount ($9 × 10) (90)

Realization of loss classified in OCI (10)

Gain on sale of investment $20

Since Investor has lost significant influence, it should discontinue accruing its share of earnings/losses in Investee. Its remaining proportionate share of Investee’s OCI of $15 (15 /25 shares × $25 recorded in OCI) should be reclassified to the carrying value of the investment.

The remaining carrying amount of the investment at the time of the disposition would be $135 ($225

net carrying amount - $90 carrying amount of interest sold). Investor would then need to mark its

remaining investment to fair value in accordance with ASC 321, resulting in an additional gain of $45

((15 shares * $12 fair value) - $135).

The journal entries to reflect Investor’s accounting for these events would be as follows:


5-21

Journal entries

20X0 Dr. Investment

Cr. Cash

$250

$250

To record acquisition of investment

Dr. OCI

Cr. Investment

$25

$25

To record share of decline in fair value of debt security recorded by Investee in OCI (25% × $100)

20X1 Dr. Cash

Cr. Investment

Cr. Realized gain on sale

$120

$90

30

To record sale of portion of investment

Dr. Realized loss on sale

Cr. OCI

$10

$10

To record recycling of portion of OCI Balance (10/25 * 25)

Dr. Investment

Cr. OCI

$15

$15

To record reclassification of remaining OCI balance on loss of significant influence ((15/25) *$25)

Dr. Investment

Cr. Gain

$45

$45

To mark the investment to its fair value ((15 shares x $12 fair value) - $135 carrying value at transition)

5.4.4 Investor fully disposes of equity method investment

An investor may dispose of an equity method investment. Equity method investments are financial

assets; therefore, transfers of equity method investments are within the scope of ASC 860, as further

discussed in EM 5.2.4.

For the purposes of calculating the gain or loss of the investment sold, the carrying amount of the

stock sold would include a proportionate share of the investor’s basis differences.


5-22

5.5 Investment after suspension of equity method losses

An investor could make a subsequent investment in an investee after having suspended the

recognition of its share of the losses of the investee. The question then arises whether this should be

accounted for as an additional investment or treated as a funding of previous losses. This is addressed

in ASC 323-10-35-29 and ASC 323-10-35-30.

ASC 323-10-35-29

If a subsequent investment in an investee does not result in the ownership interest increasing from

one of significant influence to one of control and, in whole or in part, represents, in substance, the

funding of prior losses, the investor should recognize previously suspended losses only up to the

amount of the additional investment determined to represent the funding of prior losses (see (b)).

Whether the investment represents the funding of prior losses, however, depends on the facts and

circumstances. Judgment is required in determining whether prior losses are being funded and all

available information should be considered in performing the related analysis. All of the following

factors shall be considered; however, no one factor shall be considered presumptive or determinative:

a. Whether the additional investment is acquired from a third party or directly from the investee. If

the additional investment is purchased from a third party and the investee does not obtain

additional funds either from the investor or the third party, it is unlikely that, in the absence of

other factors, prior losses are being funded.

b. The fair value of the consideration received in relation to the value of the consideration paid for

the additional investment. For example, if the fair value of the consideration received is less than

the fair value of the consideration paid, it may indicate that prior losses are being funded to the

extent that there is disparity in the value of the exchange.

c. Whether the additional investment results in an increase in ownership percentage of the investee.

If the investment is made directly with the investee, the investor shall consider the form of the

investment and whether other investors are making simultaneous investments proportionate to

their interests. Investments made without a corresponding increase in ownership or other

interests, or a pro rata equity investment made by all existing investors, may indicate that prior

losses are being funded.

d. The seniority of the additional investment relative to existing equity of the investee. An investment

in an instrument that is subordinate to other equity of the investee may indicate that prior losses

are being funded.


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ASC 323-10-35-30

Upon making the additional investment, the investor should evaluate whether it has become otherwise

committed to provide financial support to the investee.

5.6 Other investee transactions

An equity method investor may need to reflect the impact of investee transactions in the carrying

amount of its investment. Treasury transactions are addressed in EM 5.2.3. Other transactions

include:

□ Investee spinoff and spit-offs (see EM 5.6.1)

□ Common control transactions of the investee (see EM 5.6.2), and

□ Investee transactions with noncontrolling shareholders (see EM 5.6.3)

5.6.1 Investee spinoff and split-offs

A pro rata distribution of shares by an investee to shareholders (e.g., in a spinoff or other form of

reorganization or liquidation) should be accounted for as a deemed distribution to shareholders at the

carrying amount of the investment. That is, an investor who receives the distribution would allocate its

previous investment between the spinnor and the shares received in the spinoff.

A non-pro rata disposition of shares by an investee (e.g., a split-off) may give rise to a gain or loss to an

investor that is a net seller. That gain or loss would be equal to the difference between the fair value of

the investment received at the date of exchange and the investor’s carrying amount of the

proportionate share in the investee that was sold, including, if applicable, a proportionate share of any

unamortized basis differences.

5.6.2 Common control transactions of the investee

An investee may receive assets from its parent or from a sister entity with which it shares a common

parent in return for issuing additional shares. Since the transfer to the investee is considered a

common control transfer, the investee would record the receipt of the assets at the parent’s carrying

basis. A question then arises as to how a third-party investor in the investee should account for the

dilution effect of this transaction. This issue could also arise when an investee transfers assets to its

parent or sister entity in return for investee shares.

For example, assume Investor has a 40% equity method investment in Investee. The remaining 60%

interest in Investee is held by ParentCo, which consolidates Investee. ParentCo contributes additional

assets to Investee in return for additional shares. The contribution by ParentCo dilutes Investor’s

interest in Investee. In this case, Investee would account for the contribution received from ParentCo

as a common control transaction. However, Investor would determine its dilution gain or loss using

the fair value of the assets contributed and the additional interest issued to ParentCo. Investor would

track any basis differences using its memo accounts.


5-24

5.6.3 Investee transactions with noncontrolling interest holders

An investee may have a wholly-owned subsidiary and decide to sell a noncontrolling interest in the

subsidiary to third parties. Similarly, an investee may have a partially-owned subsidiary and decide to

sell an additional noncontrolling interest in the subsidiary to third parties, or acquire some or all of the

existing noncontrolling interest from the noncontrolling interest holders. From the investee’s

perspective, these transactions are considered equity transactions and are accounted for in accordance

with ASC 810, as the investee continues to have a controlling financial interest in the subsidiaries. The

accounting standards do not provide guidance on how the equity method investor should account for

these transactions.

If the investee sells a noncontrolling interest in its subsidiary, we believe the equity method investor

may account for the transaction using one of the following methods.

□ Account for the transaction as if it had sold a portion of its investment, similar to a dilution gain or

loss, and record the gain or loss in its income statement. This method follows the guidance in ASC

323-10-40-1 on how an equity method investor records a dilution gain or loss for its equity method

investment when the investee issues additional shares to another party. Under this method, the

equity method investor has sold a portion of its investment in the investee even though its

ownership percentage has not changed. This method is similar to the indirect sale approach when

an investee sells shares to other investors and the equity method investor has a decrease in its

ownership percentage in the investee. See EM 5.4.2.

□ Account for the transaction as an equity transaction and record its portion of the investee’s equity

transaction directly to its additional paid in capital. This method follows the guidance in ASC 323-

10-35-15 on how an equity method investor should record its portion of an investee’s equity

transaction in a similar manner.

If the investee acquires a noncontrolling interest in its subsidiary, we believe the equity method

investor may account for the transaction using one of the following methods.

□ Account for the transaction as if the equity method investor had acquired an additional interest in

the investee similar to a step acquisition. This method follows the guidance in ASC 323-10-35-33

on how an equity method investor records a step acquisition for its equity method investment.

Under this method, the equity method investor has effectively acquired an additional interest in

the investee even though its ownership percentage has not changed. This method is similar to the

step acquisition approach when an investee acquires shares from the other investors (treasury

stock transaction) and the equity method investor has an increase in its ownership percentage in

the investee. See EM 5.3.2. This method will likely result in the equity method investor having to

account for new or additional basis differences in its memo accounts.

□ Account for the transaction as an equity transaction and record its portion of the investee’s equity

transaction directly to its additional paid in capital. This method follows the guidance in ASC 323-

10-35-15 on how an equity method investor should record its portion of an investee’s equity

transaction in a similar manner.


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5.7 Gain or loss calculation on sale of in-substance common stock

A gain or loss could be recognized by the investor when it is a seller or net-seller of in-substance

common stock. This treatment is considered acceptable because the in-substance common stock is

determined to have risks and reward characteristics that are substantially the same as the entity’s

common stock. After the gain or loss is recognized, the investor should assess whether the investment

is still in-substance common stock.

Gains and losses arising from investee transactions of a capital nature are not currently taxable events.

Deferred taxes will have to be provided for the entire difference between the book and tax basis in the

investment, including the portion that results from a change in interest gain for all investees unless:

□ the entity is a foreign subsidiary or a foreign corporate joint venture that is essentially permanent

in duration; or

□ an entity is a domestic subsidiary for which the basis difference is a permanent difference rather

than a temporary difference.

If deferred taxes are provided on a change of interest gain reflected as a credit to investor paid-in

capital, intraperiod tax allocation must be followed. See TX 11 for further information.

PwC 1

Chapter 6: Joint ventures

Joint ventures

6-2

6.1 Joint ventures–overview

Joint ventures are popular structures for creating alliances and gaining entry to or expanding business

operations in various domestic and foreign markets. Joint ventures may be accounted for differently

than other similarly structured transactions and joint arrangements. Therefore, it is important to

properly distinguish arrangements that meet the accounting definition of a joint venture. Also,

because of the lack of definitive, authoritative accounting literature addressing joint venture

agreements, and the potentially conflicting accounting guidance often referred to by analogy (e.g., ASC

805, Business Combinations, ASC 718, Compensation—Stock Compensation, ASC 845, Nonmonetary

Transactions, ASC 970, Real Estate), accounting for joint ventures requires analysis and judgment.

Furthermore, in some cases, arrangements may be referred to as joint ventures even though they do

not meet the accounting definition of a joint venture. In other cases, a joint venture may be a variable

interest entity (VIE) (see CG 2) and one investor, or another enterprise with a variable interest in the

entity, may be the primary beneficiary required to consolidate the joint venture, in which case it does

not meet the joint control requirements for joint venture accounting.

In connection with the accounting for joint ventures, two of the most significant and difficult issues are

(1) the investor’s/venturer’s accounting for the formation of the joint venture (specifically, whether a

gain or loss can be recognized at formation for the contribution of noncash assets to the joint venture)

and (2) accounting by the joint venture for the receipt of noncash assets at formation.

This chapter discusses the definition of a joint venture and the accounting for the initial investment at

formation by the investor and the joint venture. Subsequent to the formation of a joint venture, there

is not a specific accounting model for either the investor or the joint venture. Instead, an investor

generally applies the equity method of accounting for its investment, and the joint venture applies the

relevant GAAP standards for its transactions just as any other operating entity.

Note about ongoing standard setting

The FASB has an active project that may affect the accounting by a joint venture for the receipt of

noncash assets at formation. Financial statement preparers and other users of this publication are

therefore encouraged to monitor the status of the project and, if finalized, evaluate the effective date of

the new guidance and the implications on the accounting by the joint venture.

6.2 Identifying a joint venture

In practice, the term “joint venture” is usually referred to rather loosely. Structures or transactions

that are not joint ventures for accounting purposes are commonly called joint ventures.

A corporate joint venture is defined as follows.

Definition from ASC 323-10-20

Corporate joint venture: A corporation owned and operated by a small group of entities (the joint

venturers) as a separate and specific business or project for the mutual benefit of the members of the

group. A government may also be a member of the group. The purpose of a corporate joint venture

frequently is to share risks and rewards in developing a new market, product or technology; to

combine complementary technological knowledge; or to pool resources in developing production or

other facilities. A corporate joint venture also usually provides an arrangement under which each joint

Joint ventures

6-3

venturer may participate, directly or indirectly, in the overall management of the joint venture. Joint

venturers thus have an interest or relationship other than as passive investors. An entity that is a

subsidiary of one of the joint venturers is not a corporate joint venture. The ownership of a corporate

joint venture seldom changes, and its stock is usually not traded publicly. A noncontrolling interest

held by public ownership, however, does not preclude a corporation from being a corporate joint

venture.

This definition does not include investments in unincorporated joint ventures (including

partnerships), although ASC 323-30 concludes that many of the provisions of ASC 323 are also

appropriate in assessing investments in unincorporated joint ventures. Therefore, in practice, a joint

venture is not restricted by the type or legal form of the entity. Joint venture accounting does not apply

to arrangements between entities under common control.

At the formation of a joint venture (or when an investor becomes involved with or acquires an interest

in a joint venture), an investor in the joint venture is required to first determine if the joint venture

entity is a variable interest entity (see CG 2). If the entity is a VIE and is required to be consolidated by

one of the investors, it would not meet the definition of a joint venture. The VIE model provides a

scope exception from the application of that model to a joint venture if the joint venture is a business

and certain conditions are met, which is discussed in EM 6.2.1. On the other hand, if the entity is a

VIE, but no party is required to consolidate it (including after giving effect to any related party

considerations), the entity may meet the definition of a joint venture. An entity that is a VIE and meets

the definition of a joint venture would be considered an entity over which power is shared among its

equity investors, with no investor consolidating the joint venture. If the joint venture is not a VIE, then

the investor should assess if it is required to consolidate the joint venture under the voting interest

(VOE) model (see CG 3). If the investor is not required to consolidate the joint venture under either

the VIE model or the VOE model, the investor would determine if the entity meets the definition of a

joint venture, which is discussed further in EM 6.2.2 and EM 6.2.3.

6.2.1 Applying the business scope exception to joint ventures

ASC 810-10 provides for a scope exception from the application of the VIE model to a joint venture if

the joint venture is a business and certain conditions are met. The scope exception is primarily an

investor exception (versus an entity exception). Thus, each investor in the joint venture will have to

assess whether it qualifies for the scope exception. One investor in the joint venture may qualify while

another investor may not. The application of the scope exception necessitates judgment. Due to the

characteristics of many joint ventures, qualification for the scope exception is expected to be

infrequent, so investors will generally have to assess the joint venture under the VIE guidance.

An investor in a joint venture that initially meets the requirements for the scope exception should

continually reassess that it qualifies for the scope exception. If an investor in a joint venture no longer

meets the requirements for the scope exception, the VIE model would be applied prospectively.

There is no investor scope exception from the application of the VIE guidance to a joint venture if the

joint venture is not a business.

Joint ventures

6-4

Excerpt from ASC 810-10-15-17(d)

A legal entity that is deemed to be a business need not be evaluated by a reporting entity to determine

if the legal entity is a VIE under the requirements of the Variable Interest Entities Subsections unless

any of the following conditions exist (however, for legal entities that are excluded by this provision,

other GAAP should be applied):

1. The reporting entity, its related parties, or both participated significantly in the design or redesign

of the legal entity. However, this condition does not apply if the legal entity is an operating joint

venture under joint control of the reporting entity and one or more independent parties or a

franchisee.

2. The legal entity is designed so that substantially all of its activities either involve or are conducted

on behalf of the reporting entity and its related parties.

3. The reporting entity and its related parties provide more than half of the total of the equity,

subordinated debt, and other forms of subordinated financial support to the legal entity based on

an analysis of the fair values of the interests in the legal entity.

4. The activities of the legal entity are primarily related to securitizations or other forms of asset-

backed financings or single-lessee leasing arrangements.

While the presence of any of the conditions in ASC 810-10-15-17(d) would disqualify an investor in a

joint venture from applying the scope exception, conditions ASC 810-10-15-17(d)(2) and ASC 810-10-

15-17(d)(3) are most commonly the provisions that prevent an investor from applying the business

scope exception to a joint venture.

ASC 810-10-15-17(d)(2): Substantially all

An understanding of the purpose and design of the entity is required in order to evaluate whether

substantially all of its activities either involve or are conducted on behalf of the reporting entity and its

related parties. Generally, investors form a joint venture for a specific purpose that will benefit all of

the investors, as opposed to for the benefit of just one investor. However, some joint ventures have

only two (or a few) investors, in which case it is not unusual for the substantially all of the activities to

be on behalf of one of the investors. The assessment of the substantially all criteria is primarily

qualitative, and the phrase “substantially all” does not indicate a quantitative guideline. See CG 2.1.2.4

for additional guidance.

ASC 810-10-15-17(d)(3): Subordinated financial support

Most variable interests in an entity are considered subordinated financial support. As a result, this

scope exception would generally be available only when it is obvious that the investor would not

absorb the majority of the economics of the entity on a fair value basis. For many 50:50 joint venture

arrangements, it will be difficult to make this assertion. In a 50:50 joint venture, while the economics

are intended to be shared evenly, this may not be the case. There are often commercial arrangements

between the investors and the joint venture that may be variable interests and it becomes difficult to

establish that the economics with respect to all the variable interests held by the investors are shared

equally. This means it is likely the entity will need to be evaluated under the VIE model. See CG 2.1.2.4

for additional guidance.

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Example EM 6-1 and Example EM 6-2 illustrate the application of the business scope exception

guidance in ASC 810-10-15-17(d)(2) and ASC 810-10-15-17(d)(3).

EXAMPLE EM 6-1

Determining whether an investor in a joint venture can apply the business scope exception in ASC

810-10-15-17(d)

Company A and Company B form a joint venture, Newco. Company A contributes one of its

subsidiaries, a business with a fair value of $100 million, in exchange for 50% of the equity of Newco.

Company B contributes $100 million cash in exchange for 50% of the equity of Newco. The cash

contributed by Company B will remain in Newco for operating expenses to develop new products and

markets. Newco, which is deemed to be a business, was created so that all of its activities are

conducted on behalf of Company A. Newco sells all of its output to Company A and all of Newco’s

employees are seconded from Company A. Newco obtains a $120 million, six year, fixed 5% interest

rate loan from a bank, which is guaranteed by Company A and Company B.

Company A and Company B each have two of the four board seats of Newco and unanimous approval

from all board members is required for all decisions related to Newco. The investors concluded that

Newco meets the definition of a joint venture.

Does Company A qualify for the business scope exception in ASC 810-10-15-17(d)?

Analysis

No. Newco is deemed to be a business and also meets the definition of a joint venture. However, given

that Newco sells all of its output to Company A and Company A provides all of the employees of

Newco, all of the activities of Newco are deemed to be conducted on behalf of Company A. Therefore,

the business scope exception is not available to Company A as the condition in ASC 810-10-15-17(d)(2)

which precludes use of the exception exists. Company A would need to evaluate its investment in

Newco under the VIE model. See CG 2.3 for additional guidance.

EXAMPLE EM 6-2

Determining whether an investor in a joint venture can apply the business scope exception in ASC

810-10-15-17(d)

Company A and Company B form a joint venture, Newco, for the purpose of developing new products

and accessing new markets. Company A contributes cash in exchange for 50% of the equity of Newco,

and Company B contributes a division of its operations (that constitutes a business) in exchange for

50% of the equity of Newco. Company B also provides a loan to Newco to fund its working capital

requirements.

Company A and Company B each have two of the four board seats of Newco and unanimous approval

from all board members is required for all decisions related to Newco. The investors concluded that

Newco meets the definition of a joint venture.

Does Company B qualify for the business scope exception in ASC 810-10-15-17(d)?

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Analysis

No. Newco is deemed to be a business and also meets the definition of a joint venture. However,

Company B is providing more than half of the total subordinated financial support to Newco through

its 50% equity interest and the working capital loan to Newco. Therefore, the business scope exception

is not available to Company B as the condition in ASC 810-10-15-17(d)(3) that precludes use of the

exception exists. Company B would need to evaluate its investment in Newco under the VIE model.

See CG 2.3 for additional guidance.

6.2.2 Joint control

The most distinctive characteristic of a joint venture is the concept of joint control. An AcSEC Issue

Paper, which is not authoritative guidance, describes the concept of joint control in its definition of a

joint venture. This definition and the concept of joint control are widely applied in practice.

Definition from AcSEC Issue Paper, Joint Venture Accounting (7/17/79), Paragraph

51(b)

Joint venture: An arrangement whereby two or more parties (the venturers) jointly control a specific

business undertaking and contribute resources towards its accomplishment. The life of the joint

venture is limited to that of the undertaking which may be of short or long-term duration depending

on the circumstances. A distinctive feature of a joint venture is that the relationship between the

venturers is governed by an agreement (usually in writing) which establishes joint control. Decisions

in all areas essential to the accomplishment of a joint venture require the consent of the venturers, as

provided by the agreement; none of the individual venturers is in a position to unilaterally control the

venture. This feature of joint control distinguishes investments in joint ventures from investments in

other enterprises where control of decisions is related to the proportion of voting interest held.

The AcSEC definition establishes joint control over the decision-making process as the most

significant attribute of joint ventures, regardless of the form of legal ownership or voting interest held.

That is, the type of legal entity (e.g., corporation, partnership) is not relevant as long as the entity’s

governing documents provide for each venturer to exercise joint control. There is a distinction

between “joint control over decision making” and a structure in which no single party has “control”

over decision making. The latter does not meet the definition of a joint venture as all investors need

not agree in order to approve an entity’s action.

Joint control exists when the investors are able to participate in all of the significant decisions of an

entity. An understanding of the governance structure of the entity is necessary to determine whether

there is joint control over the significant decisions of the venture by all venturers. At times, power over

the significant decisions of the entity may rest with the board of directors; however, the rights of all

venturers should be considered in making the assessment as to whether joint control exists. The

venturers, therefore, at a minimum, must be able to effectively participate in those significant

decisions through substantive veto or approval rights. To be substantive, these rights must have no

significant barriers to exercise (i.e., significant penalties or other hurdles making it difficult or unlikely

they could be exercised).

Joint control can still exist when public shareholders own interests in a joint venture. The definition of

a joint venture indicates that, while stock of a joint venture is usually not traded publicly, a

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noncontrolling interest held by public ownership does not preclude a corporation from being a

corporate joint venture. In the unusual instance when the public has an equity interest in a joint

venture, that interest is usually small relative to the other venturers’ interests and does not provide the

public shareholders with a means to actively participate in all significant decision-making of the joint

venture. In such cases, joint control can still exist if control rests jointly with the venturers excluding

the public shareholders.

Given that joint control requires unanimous consent over all significant decisions by all the venturers,

it is not uncommon for venturers to disagree on certain significant decisions. In these cases, it is

important to understand how disagreements are resolved. Sometimes, when the venturers cannot

agree, no action is approved and no further action on that issue is taken by the venturers or venture.

Other times, the dispute may go to arbitration for resolution. Settlement of disputes through

arbitration does not preclude the investors from having joint control; however, if one investor has tie-

breaking authority in the event of a dispute, joint control does not exist.

Some investors may also have unilateral control over decisions that are not significant to the joint

venture’s operations (e.g., selecting the auditor of the joint venture). Because these decisions are

considered protective rather than participating, joint control over these decisions is not required. In

these cases, the venturers would still be deemed to have joint control over the significant decisions.

Question EM 6-1, Question EM 6-2, and Question EM 6-3 discuss joint ventures that have more than

two venturers. Question EM 6-4 addresses whether all venturers are required to have an equal

ownership interest in the joint venture.

Question EM 6-1

Can a joint venture have more than two venturers?

PwC response

Yes, provided the joint venture satisfies all of the requirements in the definition of a joint venture,

including the requirement for joint control by all venturers. Thus, each venturer in the joint venture

would need to participate in the joint control over the joint venture.

Question EM 6-2

Assume three investors create a new entity, with each investor owning one-third of the equity of the new entity, and each having one-third of the investor votes. Investor approval over significant decisions of the new entity requires a simple majority of the investor votes. Does this qualify as joint control?

PwC response

No, although no investor controls the entity, a majority vote in this case means that only two of the

three investors are needed to make the significant decisions of the new entity. This does not meet the

concept of joint control. However, joint control would exist if investor approval over significant

decisions required a unanimous decision by all three investors.

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Question EM 6-3

Assume three investors create a new entity, with each investor owning one-third of the equity and significant decisions require unanimous approval of all three investors. If the investors cannot agree on a decision within 30 days after the initial disagreement, an independent arbitrator will be engaged to resolve the issue within 25 business days once engaged. Does this qualify as joint control?

PwC response

Yes, joint control exists as investor approval over significant decisions requires a unanimous vote of all

investors. The use of an arbitrator to aid in the resolution of a potential disagreement does not negate

the joint control terms as stipulated in the joint venture agreement. The arbitrator is only engaged and

used when there is a disagreement among the three investors and generally would not be making the

significant decisions on an ongoing basis.

Question EM 6-4

Are all venturers required to have an equal ownership interest in the joint venture (e.g., are two venturers in a joint venture required to each have a 50% ownership interest in the joint venture)?

PwC response

No, the definition of a joint venture does not require that each investor have an equal ownership

interest in the joint venture. However, care should be exercised when evaluating a joint venture when

there is not equal ownership among the investors as that might indicate the venture does not meet the

definition of a joint venture (e.g., there may be a lack of joint control among the venturers). For

instance, significant differences in ownership interests among investors may raise questions as to why

an investor with proportionately greater economic interest would permit lower economic interest

investors to have the same level of participation over the significant decisions of the entity.

6.2.3 Other characteristics

In addition to joint control, there are other characteristics that must be met in order for an entity to

meet the definition of a joint venture, as described in ASC 323-10-20. That is, joint control alone is not

sufficient to obtain joint venture accounting. At the 2014 AICPA National Conference on Current SEC

and PCAOB Developments, the SEC staff stated that each of the characteristics in the definition of a

joint venture should be met for an entity to be a joint venture, including that the purpose of the entity

is consistent with that of a joint venture.

ASC 845-10-S99-2 states that the existence of joint control is not the only defining characteristic when

determining whether an entity is a joint venture, rather, the other characteristics of a joint venture also

need to be present. While the other characteristics might appear to be broad in nature and lacking of

specific guidance on how an entity would meet them (versus, for example, the joint control

characteristic), an entity should exercise reasonable judgment in assessing whether it has met the

additional characteristics. In making this assessment, the factors to consider include the purpose,

nature, and operations of the entity.

For example, if the substance of a transaction is primarily to combine two or more existing operating

businesses, which are either separate subsidiaries or divisions of a larger company, in an effort to

generate synergies such as economies of scale or cost reductions and/or to generate future growth

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opportunities, such a transaction may be considered a merger that should be accounted for as a

business combination under ASC 805 rather than as a joint venture. In this fact pattern, determining

whether the purpose of the transaction is consistent with the definition of a joint venture as described

in ASC 323 requires significant judgment.

Example EM 6-3, Example EM 6-4, Example EM 6-5, and Example EM 6-6 illustrate some of the

accounting considerations when evaluating whether an entity meets the definition of a joint venture

for accounting purposes.

EXAMPLE EM 6-3

Determining whether a joint venture is formed when each investor contributes its entire operations to

a new entity

Company A, a holding company, owns Company B, which has a fair value of $500 million, and

represents all of Company A’s operations. Company C, a holding company, owns Company D, which

has a fair value of $400 million, and represents all of Company C’s operations. Company A and

Company C agree to combine their operating businesses in a newly established entity, Newco.

Company A contributes Company B in exchange for 55% equity and joint control of Newco. Company

C contributes Company D in exchange for 45% equity and joint control of Newco. Company A and

Company C each have two members on the four member board of directors and unanimous approval

from all board members is required for all decisions related to Newco. Other than joint control, none

of the other characteristics of a joint venture as described in ASC 323 exist.

Does this arrangement meet the definition of a joint venture for accounting purposes?

Analysis

No. Newco does not meet the definition of a joint venture. Although the investors appear to have joint

control, both investors have contributed their entire operations, and therefore would likely not meet

the aspect of the definition that describes the purpose of a joint venture. This transaction was likely for

the purpose of achieving economies of scale or cost reductions as opposed to the purpose of sharing

risks and rewards in developing a new market, product, or technology; combining complementary

technological knowledge; or pooling resources in developing production or other facilities.

EXAMPLE EM 6-4

Determining whether a joint venture is formed when one investor contributes a business and the other

investor contributes cash to a new entity

Company A, a holding company, owns various businesses including Company B, which has a fair value

of $500 million. Company A and Company C agree to form a joint venture, Newco, as they have plans

for new product offerings and expansion into new markets. Company A contributes Company B in

exchange for 50% equity and joint control of Newco. Company C contributes $500 million cash in

exchange for 50% equity and joint control of Newco. The cash will remain in Newco to be used for

ongoing operating expenses, developing new products, and developing new production facilities.

Company A and Company C each have two members on the four member board of directors and

unanimous approval from all board members is required for all decisions related to Newco.


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Analysis

Yes. Newco meets the definition of a joint venture for accounting purposes. Company A and Company

C have each made contributions in exchange for joint control of the new entity. The purpose for the

entity is consistent with that of a joint venture as the venture will use the cash invested by Company C

to gain access to new markets and to develop new products.

EXAMPLE EM 6-5

Whether a joint venture is formed when one investor sells 50% of an existing operating subsidiary

Company A, a holding company, owns Company B, which has a fair value of $500 million, and

represents all of Company A’s operations. Company A has decided to cash out a portion of its existing

business. To facilitate the transaction, Company A and Company C agree to form a new company,

Newco, which the two investors will jointly own and jointly control. Company A contributes Company

B in exchange for 100% of the equity of Newco. Company C pays $250 million cash to Company A in

exchange for 50% of its equity in Newco. Company A and Company C each have two members on the

four member board of directors and unanimous approval from all board members is required for all

decisions related to Newco.


Analysis

No. While the investors have joint control over Newco, the substance of the transaction is that

Company A has sold 50% of its business in exchange for cash. As the purpose of the transaction does

not meet any of the other characteristics as described in ASC 323-10-20, this arrangement does not

meet the definition of a joint venture for accounting purposes.

EXAMPLE EM 6-6

A joint venture structured in the form of a partnership

Company A and Company B form a new venture, Newco Partnership, a limited partnership. The

general partner (GP) of Newco Partnership is Company C Corporation, a newly formed entity jointly

owned and controlled by Company A and Company B. Company A owns 100% of Company A LLC,

which has a 40% limited partnership interest in Newco Partnership. Company B owns 100% of

Company B LLC, which has a 40% limited partnership interest in Newco Partnership. The GP owns

the remaining 20% general partnership interest in Newco Partnership. The GP has the unilateral right

to make all the decisions of Newco Partnership and the LPs do not have any participating rights or

kick-out rights. Company A and Company B are not related parties.

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Does Newco Partnership meet the definition of a joint venture?

Analysis

Yes. Assuming all of the other characteristics in ASC 323-10-20 are met, Newco Partnership would

meet the definition of an accounting joint venture since Company A and Company B have joint control

over the GP, which controls Newco Partnership. In this case, the substance of the arrangement is that

the two companies have joint control over the joint venture.

6.2.4 Joint venture vs collaborative arrangements

Investors may enter into arrangements that are considered collaborative arrangements rather than

joint ventures for accounting purposes. A collaborative arrangement is a series of contracts between

two or more parties that involves a joint operating activity, as described in ASC 808. It can be used for

a particular purpose (e.g., marketing products) and in many cases does not include a joint ownership

in assets. Such arrangements are not joint ventures. See CG 4.3 for discussion of collaborative

arrangements.

6.3 Accounting for the joint venture by the investor

Once it has been determined that a joint venture should not be consolidated pursuant to ASC 810, an

investment in a joint venture is generally accounted for under the equity method of accounting

pursuant to ASC 323.

When an investor contributes a business, or a group of assets that represents a business, to a joint

venture, the investment is generally recorded at fair value, as described in EM 6.3.1.1. Similarly, when

an investor contributes nonfinancial assets that do not represent a business to a joint venture, the

investment is generally recorded at fair value, as discussed in EM 6.3.1.2.

In some cases, an investor may elect the fair value option to account for its investment in a joint

venture, or it may meet the requirements for proportionate consolidation, which are both discussed in

EM 6.3.2.

6.3.1 Investor accounting for an investment in a JV at formation

ASC 323 provides guidance regarding the initial measurement of an investment in a joint venture as

follows.

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ASC 323-10-30-2

Except as provided in the following sentence, an investor shall measure an investment in common

stock of an investee (including a joint venture) initially at cost in accordance with the guidance in

Section 805-50-30. An investor shall initially measure, at fair value, the following:

a. A retained investment in the common stock of an investee (including a joint venture) in a

deconsolidation transaction in accordance with paragraphs 810-10-40-3A through 40-5.

b. An investment in the common stock of an investee (including a joint venture) recognized upon the

derecognition of a distinct nonfinancial asset or distinct in substance nonfinancial asset in

accordance with Subtopic 610-20.

6.3.1.1 Contribution of a business

ASC 805 defines a business as follows.

Definition from ASC 805-10-55-3A

A business is an integrated set of activities and assets that is capable of being conducted and managed

for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits

directly to investors or other owners, members, or participants.

See BCG 1 and ASC 805-10 for further information on what constitutes a business.

When an investor contributes a subsidiary or group of assets that constitute a business to a joint

venture, the investor should apply the deconsolidation and derecognition guidance in ASC 810-10-40

and record any consideration received for its contribution at fair value (including its interest in the

joint venture). This generally results in a gain or loss on the contribution.


A parent shall account for the deconsolidation of a subsidiary or derecognition of a group of assets

specified in paragraph 810-10-40-3A by recognizing a gain or loss in net income attributable to the

parent, measured as the difference between:

a. The aggregate of all of the following:

1. The fair value of any consideration received.

2. The fair value of any retained noncontrolling investment in the former subsidiary or group

of assets at the date the subsidiary is deconsolidated or the group of assets is derecognized.

3. The carrying amount of any noncontrolling interest in the former subsidiary at the date the subsidiary is deconsolidated.

b. The carrying amount of the former subsidiary’s assets and liabilities or the carrying amount of the

group of assets.

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This guidance does not apply if the investor’s contribution is a conveyance of oil and gas mineral

rights. An investor would apply the guidance in ASC 932 to account for these types of contributions to

the joint venture.

Example EM 6-7 illustrates the accounting considerations when an investor contributes a business to a

joint venture. See BCG 5.5 for examples of the accounting by an investor upon deconsolidation of a

business.

EXAMPLE EM 6-7

Investor accounting for a contribution of a business to a joint venture

Company A has three reporting units, X, Y, and Z. Business B is one of several businesses within

Company A’s reporting unit X. Company A previously assigned goodwill from a prior acquisition to

reporting unit X. Company A has entered into an agreement with an unrelated third party to form a

50:50 joint venture, Newco, and will contribute Business B to Newco. Assume Newco meets the

definition of a joint venture, does not qualify as a variable interest entity under ASC 810-10, and will

be accounted for as an equity investment in the financial statements of Company A under ASC 323.

How should Company A account for its investment in Newco?

Analysis

The guidance in ASC 810-10 should be followed when a subsidiary that is a business is transferred to a

joint venture. Therefore, Company A should realize a gain or loss following the guidance in ASC 810-

10-40-5. The carrying amount of Business B should include an allocation of reporting unit X’s goodwill

following the guidance in ASC 350-20-35-51 as the contribution of a business to a joint venture is

analogous to other disposals (e.g., a sale, abandonment, spin-off).

The gain/loss would consist of two parts, the realized gain/loss on the effective sale of the 50% interest

in Business B to the unrelated third party, and the unrealized gain/loss from the remeasurement to

fair value of the 50% noncontrolling investment effectively retained in Business B.

6.3.1.2 Contribution of assets that do not represent a business

An investor may contribute a subsidiary (or group of assets) that is a nonfinancial asset or in substance

nonfinancial asset and not a business to a joint venture. In these cases, the investor should record its

joint venture investment in accordance with ASC 610-20 (provided other guidance is not applicable,

e.g., ASC 860, ASC 932). See PPE 6.2 for guidance on the derecognition of nonfinancial assets and in

substance nonfinancial assets.

6.3.1.3 Contribution of services to a noncustomer

A gain should not be recognized on receipt of an interest in a joint venture if some or all of the

investor’s interest was received for future services to be rendered, as this implies continuing

involvement through a future obligation.

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6.3.1.4 Differences in accounting

An investor and investee may apply different accounting principles (e.g., US GAAP, IFRS) and

different accounting policies (e.g., LIFO or FIFO method of inventory costing) in the preparation of

their financial statements. A public company investor may have an equity method investment in a

private company investee that has elected a private company accounting alternative. Further, an

investor and an investee might adopt new accounting standards in different periods. See EM 4.3.4 for

a discussion of these topics.

6.3.2 Other investor accounting methods

In some cases, an investor may elect the fair value option to account for its investment in a joint

venture, or it may meet the requirements for proportionate consolidation. See EM 1.4.5 and EM 1.4.6

for a discussion of the fair value option and the proportionate consolidation method, respectively.

6.3.3 Restructuring and impairment charges

When joint ventures are created by contributing assets and/or businesses from existing entities,

certain restructuring and impairment charges are often anticipated. For example, there may be plans

to close certain operating plants or reduce personnel. Such restructurings and impairments are

typically an integral part of the negotiations between the venture partners. See PPE 5 for a discussion

of impairment under ASC 360-10 and ASC 420, Exit or Disposal Cost Obligations.

Question EM 6-5 discusses the accounting by an investor that contributes a facility (e.g., a plant)

expected to be shut down at or shortly after formation of the joint venture.

Question EM 6-5

If an investor contributes a plant that is expected to be shut down at or shortly after formation of the joint venture, should expenses associated with shutting down the plant be recognized by the investor?

PwC response

Determining whether the investor or joint venture should bear the cost of restructuring activities

related to assets being contributed to a joint venture that are initiated in anticipation of the formation

of the joint venture and in agreement with the other joint venture partner requires significant

judgment. An assessment should be made to determine whether the restructuring costs are more

appropriately the responsibility of the investor or the joint venture.

An impairment of assets that would otherwise be required under US GAAP cannot be avoided by

contributing the assets to a joint venture. This would apply, for example, to lower of cost and net

realizable value write-downs for inventory or impairments of long-lived assets.

If after formation, the joint venture decides to restructure operations of the contributed plant and such

restructuring was not contemplated in the joint venture formation, the restructuring costs should be

recognized in the accounts of the joint venture.

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6.3.4 Start-up and organization costs

Costs incurred by an investor directly related to the organization of a joint venture should be expensed

as incurred in accordance with ASC 720-15-25-1, as they are considered akin to start-up costs incurred

in the formation of a new entity.

6.3.5 Cumulative translation adjustment accounts

An investor may decide to contribute a portion or all of its foreign operations that constitute a business

to a joint venture. This would result in the investor deconsolidating a portion or all of its foreign

operations. In these cases, the investor needs to determine whether its investment in the joint venture

results in a deconsolidation event within a foreign entity or a deconsolidation event of a foreign entity,

as described in ASC 830-10. If it is deemed a deconsolidation event within a foreign entity, the

investor would not release any of its cumulative translation adjustments (“CTA”) into earnings unless

such deconsolidation event represents a complete or substantially complete liquidation of the foreign

entity. In contrast, if it is deemed a deconsolidation event of a foreign entity, the investor would

release all of its CTAs related to the derecognized foreign entity, even when a noncontrolling

investment is retained. See FX 8 for additional information regarding this determination.

6.3.6 Tax basis differences

Sometimes an investor may recognize its investment in a joint venture at fair value, while for tax

purposes its investment in the joint venture was not deemed to be a taxable transaction. This would

result in a difference in the book and tax basis of the investment. See TX 11 for further details

regarding the impact to the investor when tax basis differences exist.

6.3.7 Dissolution of a joint venture

When a joint venture is terminated by its investors, the net assets of the joint venture may be

distributed to the investors or sold to a third party. Example EM 6-8 illustrates the accounting by an

investor for the receipt of the net assets of the joint venture upon its termination.

EXAMPLE EM 6-8

Accounting for an investor’s receipt of a distribution of net assets constituting a business from its joint

venture

During 20X2, Company A and Company B established a joint venture, Newco, through the

contribution of nonmonetary assets. Book values of the nonmonetary assets were equal to fair values

at the time of the contribution. Since Company A and Company B have joint control over Newco and

Newco meets the definition of an accounting joint venture, each investor accounts for its investment

under the equity method of accounting.

During 20X4, the investors decide to end their joint venture in Newco and proceed with a plan to

distribute the net assets of the venture to the investors in proportion to their 50:50 ownership interest.

Newco distributes its assets such that each investor receives 50% of the total asset value. Each group of

net assets received by the two investors constitutes a business as defined by ASC 805-10-20.

What is the accounting for the liquidating distribution of the net assets of Newco to the investors of

Newco upon its termination?

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Analysis

Each investor effectively owned a 50% noncontrolling equity interest in each business prior to the

dissolution. In the dissolution, each investor would exchange its 50% equity investment in one of the

businesses for a controlling financial interest in the other business. Therefore, given that each investor

would obtain control of a business, the investor’s accounting is within the scope of ASC 805 and ASC

810-10, and should be accounted for using the guidance for a business combination achieved in stages.

In this scenario, a gain (or loss) would be recognized on both the interest sold (which represents a

business) and the remeasurement of the previously held equity interest effectively retained (which also

represents a business). The transaction would be accounted for by Company A as follows.

At the time of the transaction, assume Newco’s net assets have a fair value of $400 million and a book

value of $300 million attributable evenly between the two businesses. As a result, Company A

effectively sells its 50% in a business (with a fair value of $200 million and book value of $150

million), and acquires control of a business by purchasing the 50% interest in the other business (also

with a fair value of $200 million and book value of $150 million) for which Company A had a

previously held equity interest. Company A would record its basis in the acquired business based on

the consideration transferred of $200 million (fair value of business sold) and record the assets

acquired and liabilities assumed, including the remeasurement of its previously held equity interest.

Company A would recognize a total gain of $50 million on the transaction as follows.

Dr. Net assets of business acquired $200 million

Cr. Investment in Newco $150 million

Cr. Gain on previously held equity interest $ 25 million

Cr. Gain on sale of business to Company B $ 25 million

If the equity investment in Newco was exchanged for net assets that did not constitute a business, the

transaction would not fall within the scope of ASC 805.

6.4 Accounting by the joint venture

The guidance in this section applies only to entities that meet the definition of a joint venture as

discussed in EM 6.2. Generally, the most significant accounting issue the joint venture will need to

address is the amount at which to record noncash capital contributions received from its investors.

There is little authoritative guidance on accounting by a joint venture for contributed nonmonetary

assets.

Note about ongoing standard setting

The FASB has an active project that may affect the accounting by the joint venture for the receipt of

noncash assets at formation. Financial statement preparers and other users of this publication are

therefore encouraged to monitor the status of the project and, if finalized, evaluate the effective date of

the new guidance and the implications on the accounting by the joint venture.

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6.4.1 Initial contributions to the joint venture

Generally, noncash contributions to a joint venture are recognized by the joint venture at the lower of

the investor’s carryover basis or fair value.

Prior to the issuance of ASC 810, Consolidation and ASC 610-20, Gains and losses from the

derecognition of nonfinancial assets, both the investor (venturer) and the joint venture applied

carryover basis when recognizing transactions involving the exchange of noncash assets for equity at

formation, except in certain limited circumstances. The issuance of ASC 810 and more recently ASC

610-20 changed the accounting by the investor. Because the exchange of a business for a

noncontrolling equity investment results in a loss of control over the business, ASC 810 acknowledges

that this is a significant economic realization event that changes the nature of the retained

noncontrolling investment. As a result, as discussed in EM 6.3.1.1, investors that transfer a subsidiary

(or a group of assets) meeting the definition of a business generally recognize the initial equity

investment at fair value. Similarly, ASC 610-20 requires the investor to record its investment in the

joint venture at fair value when contributing nonfinancial assets or in substance nonfinancial assets

that do not meet the definition of a business to the joint venture.

The resulting asymmetry in accounting basis between the investor and the joint venture created by

ASC 810 and ASC 610-20 evoked a debate about whether it may be appropriate for the joint venture to

also record the contributed business or nonfinancial assets at fair value. Given the changes to the

investor’s accounting models, recent statements made by the standard setters have indicated that

there may be instances when it may be appropriate to accept contributions being recorded at fair value

at the joint venture level. As noted in EM 6.4, the FASB has an active project on this topic that may

affect the accounting by the joint venture for the receipt of noncash assets at formation.

6.4.1.1 SEC registrant joint ventures

The SEC staff has historically taken the view that the joint venture can elect to record the investor’s

contributions at fair value only when all of the following conditions are met:

□ Noncash assets are contributed by an investor into a newly formed venture and, after the

transaction, the investor does not control the venture.

□ The other investor contributes cash in an amount equal to the fair value of the noncash assets (fair

value must be objectively determinable) contributed by the first venturer, and such cash remains

in the joint venture or is used by the joint venture in transactions with parties other than the

venturers.

□ The investors have joint control over the joint venture.

□ The investors are unaffiliated.

□ Neither investor in the joint venture has preference in the allocation of equity or profits or losses

(i.e., the profit split conforms to the ownership arrangement).

The SEC staff has also stated that a partial step-up in basis (to the extent that property has been

“acquired” by the investor contributing cash) may be permitted in the following circumstances:

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□ Investor B acquires for cash a one-half interest in certain assets directly from Investor A. Both

investors then contribute their interests in the assets to a new entity. Assume the new entity meets

the definition of a joint venture as described in ASC 323-10-20.

□ Investor A contributes certain assets to a new entity. Investor B acquires for cash a one-half

interest in the new entity directly from Investor A. Assume the new entity meets the definition of a

joint venture as described in ASC 323-10-20. (In the SEC staff’s view, this transaction is, in

substance, the same as the first transaction and should be accounted for in a consistent manner.)

In these circumstances, the contributed property would be recorded on the books of the joint venture

at 50% carrying value (Investor A’s carrying basis) and 50% fair value (Investor B’s carrying basis). A

100% step-up in basis to fair value has historically not been permitted, since cash was not contributed

to the venture. A partial step-up would also be permitted in a scenario economically similar to the

second circumstance, but where Investor B contributes cash into the joint venture and the cash is then

distributed from the joint venture to Investor A.

The SEC staff has indicated that in certain limited circumstances, an investor’s contribution of recently

acquired property from an independent third party could serve to validate the fair value of the other

investor’s contributions and justify recording the joint venture’s assets at fair value.

The SEC staff has also stated that application of the above accounting guidelines to a joint venture with

other than equal ownership (but joint control) would have to be evaluated on a case-by-case basis.

Example EM 6-9 illustrates joint venture accounting for tangible and intangible assets received upon

formation of the venture.

EXAMPLE EM 6-9

Joint venture accounting for tangible and intangible assets received upon formation of the venture

Company A and Company B are unaffiliated entities that form an SEC-registered joint venture. Each

investor has a 50% equity interest and joint control over the joint venture. Company A contributes a

business from one of its divisions that has a net carrying value of $5 million and a fair value of $10

million. The $10 million includes $9 million for tangible assets and $1 million for identifiable

intangible assets. Company B contributes $10 million in cash that will remain in the joint venture to

fund operating expenses. The venture meets the other characteristics of a joint venture.

How should the contributed assets be recorded by the joint venture?

Analysis

Since the joint venture has met the SEC’s conditions for recognizing the contributions at fair value, the

joint venture may elect to record total assets of $20 million — $10 million in cash, $9 million for

tangible assets, and $1 million for the identifiable intangible assets. The joint venture may also record

total assets of $15 million — $10 million in cash and $5 million for the business, since carryover basis

is an acceptable measurement method upon formation of a joint venture.

Regardless of how the joint venture accounts for the contribution, Company A would record a gain

upon losing control of a previously consolidated business following the guidance in ASC 810-10-40-5.

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6.4.1.2 Non-registrant joint ventures

Given the lack of guidance for the accounting for contributions received by a joint venture, entities

generally look to the SEC guidance discussed in EM 6.4.1.1 in determining when fair value would be

appropriate at the joint venture level.

Recording the investor contributions at carrying value in the nonregistrant joint venture financial

statements continues to be appropriate, especially in the following scenarios:

□ Noncash assets are contributed whose fair value is not readily determinable with a high degree of

reliability, which may be the case when all investors contribute noncash assets.

□ Noncash assets are contributed for which the recoverability of their fair value is in doubt. For

example, internally developed intangible assets contributed to a joint venture will often be

recorded at the investor’s basis (usually zero).

6.4.2 Tax basis differences

Noncash assets contributed to a joint venture that are recorded at fair value by the joint venture may

have a lower tax basis that carries over from the investor to the venture. In these situations, the

different bases of the assets for book vs. tax purposes would be a temporary difference for which

deferred taxes should be recorded by the joint venture at the date of contribution, if the joint venture is

a taxable entity. See TX 11 for further information.

6.4.3 Conforming accounting policies

At its inception, the joint venture establishes its own accounting policies. Typically, these are selected

from those of the investors. Adoption of these accounting policies is not considered a change in the

joint venture’s accounting policies under ASC 250-10 and Regulation S-X Rule 10-01; rather, it

represents the initial selection by the joint venture of its own accounting policies.

6.4.4 Joint venture’s investment in a venturer

A joint venture (investee) may hold an equity investment in one of its venturers (investors). See EM

4.3.5 for a discussion of the acceptable accounting methods in this scenario.

Documents

Equity method investments and joint ventures (issued